XETR:PHM7 Altria Group Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

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

For the quarterly period ended March 31, 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 1-08940

 

 

Altria Group, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Virginia   13-3260245
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)

6601 West Broad Street,

Richmond, Virginia

  23230
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code (804) 274-2200

 

 

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 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 (§232.405 of this chapter) 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.

 

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

At April 16, 2012, there were 2,034,843,783 shares outstanding of the registrant’s common stock, par value $0.33 1/3 per share.

 

 

 


Table of Contents

ALTRIA GROUP, INC.

TABLE OF CONTENTS

 

          Page No.  
PART I -    FINANCIAL INFORMATION   
Item 1.    Financial Statements (Unaudited)   
  

Condensed Consolidated Balance Sheets at March 31, 2012 and December 31, 2011

     3 –4   
  

Condensed Consolidated Statements of Earnings for the Three Months Ended March 31, 2012 and 2011

     5   
  

Condensed Consolidated Statements of Comprehensive Earnings for the Three Months Ended March 31, 2012 and 2011

     6   
  

Condensed Consolidated Statements of Stockholders’ Equity for the Year Ended December 31, 2011 and the Three Months Ended March 31, 2012

     7   
  

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011

     8 – 9   
   Notes to Condensed Consolidated Financial Statements      10 –55   
Item 2.   

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

     56 –88   
Item 4.    Controls and Procedures      89   
PART II -    OTHER INFORMATION   
Item 1.    Legal Proceedings      90   
Item 1A.    Risk Factors      90   
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      90   
Item 6.    Exhibits      91 –92   
Signature         93   

 

-2-


Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements.

Altria Group, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(in millions of dollars)

(Unaudited)

 

     March 31,      December 31,  
     2012      2011  

ASSETS

     

Consumer products

     

Cash and cash equivalents

   $ 4,156       $ 3,270   

Receivables

     244         268   

Inventories:

     

Leaf tobacco

     932         934   

Other raw materials

     178         170   

Work in process

     310         316   

Finished product

     410         359   
  

 

 

    

 

 

 
     1,830         1,779   

Deferred income taxes

     1,207         1,207   

Other current assets

     456         607   
  

 

 

    

 

 

 

Total current assets

     7,893         7,131   

Property, plant and equipment, at cost

     4,737         4,728   

Less accumulated depreciation

     2,572         2,512   
  

 

 

    

 

 

 
     2,165         2,216   

Goodwill

     5,174         5,174   

Other intangible assets, net

     12,093         12,098   

Investment in SABMiller

     5,965         5,509   

Other assets

     1,235         1,257   
  

 

 

    

 

 

 

Total consumer products assets

     34,525         33,385   

Financial services

     

Finance assets, net

     3,247         3,559   

Other assets

     43         18   
  

 

 

    

 

 

 

Total financial services assets

     3,290         3,577   
  

 

 

    

 

 

 

TOTAL ASSETS

   $ 37,815       $ 36,962   
  

 

 

    

 

 

 

See notes to condensed consolidated financial statements.

Continued

 

-3-


Table of Contents

Altria Group, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets (Continued)

(in millions of dollars, except share and per share data)

(Unaudited)

 

     March 31,
2012
    December 31,
2011
 

LIABILITIES

    

Consumer products

    

Current portion of long-term debt

   $ 600      $ 600   

Accounts payable

     328        503   

Accrued liabilities:

    

Marketing

     474        430   

Taxes, except income taxes

     280        220   

Employment costs

     75        225   

Settlement charges

     4,538        3,513   

Other

     1,338        1,311   

Income taxes

     309     

Dividends payable

     839        841   
  

 

 

   

 

 

 

Total current liabilities

     8,781        7,643   

Long-term debt

     13,089        13,089   

Deferred income taxes

     4,932        4,751   

Accrued pension costs

     1,154        1,662   

Accrued postretirement health care costs

     2,367        2,359   

Other liabilities

     590        602   
  

 

 

   

 

 

 

Total consumer products liabilities

     30,913        30,106   

Financial services

    

Deferred income taxes

     2,514        2,811   

Other liabilities

     652        330   
  

 

 

   

 

 

 

Total financial services liabilities

     3,166        3,141   
  

 

 

   

 

 

 

Total liabilities

     34,079        33,247   

Contingencies (Note 10)

    

Redeemable noncontrolling interest

     32        32   

STOCKHOLDERS’ EQUITY

    

Common stock, par value $0.33 1/3 per share (2,805,961,317 shares issued)

     935        935   

Additional paid-in capital

     5,633        5,674   

Earnings reinvested in the business

     23,720        23,583   

Accumulated other comprehensive losses

     (1,685     (1,887

Cost of repurchased stock (771,030,556 shares in 2012 and 761,542,032 shares in 2011)

     (24,902     (24,625
  

 

 

   

 

 

 

Total stockholders’ equity attributable to Altria Group, Inc.

     3,701        3,680   

Noncontrolling interests

     3        3   
  

 

 

   

 

 

 

Total stockholders’ equity

     3,704        3,683   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 37,815      $ 36,962   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

-4-


Table of Contents

Altria Group, Inc. and Subsidiaries

Condensed Consolidated Statements of Earnings

(in millions of dollars, except per share data)

(Unaudited)

 

     For the Three Months Ended March 31,  
     2012     2011  

Net revenues

   $ 5,647      $ 5,643   

Cost of sales

     1,792        1,795   

Excise taxes on products

     1,653        1,700   
  

 

 

   

 

 

 

Gross profit

     2,202        2,148   

Marketing, administration and research costs

     534        601   

Asset impairment and exit costs

     21        2   

Amortization of intangibles

     5        6   
  

 

 

   

 

 

 

Operating income

     1,642        1,539   

Interest and other debt expense, net

     293        278   

Earnings from equity investment in SABMiller

     (178     (189
  

 

 

   

 

 

 

Earnings before income taxes

     1,527        1,450   

Provision for income taxes

     554        512   
  

 

 

   

 

 

 

Net earnings

     973        938   

Net earnings attributable to noncontrolling interests

       (1
  

 

 

   

 

 

 

Net earnings attributable to Altria Group, Inc.

   $ 973      $ 937   
  

 

 

   

 

 

 

Per share data:

    

Basic earnings per share attributable to Altria Group, Inc.

   $ 0.48      $ 0.45   
  

 

 

   

 

 

 

Diluted earnings per share attributable to Altria Group, Inc.

   $ 0.48      $ 0.45   
  

 

 

   

 

 

 

Dividends declared

   $ 0.41      $ 0.38   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

-5-


Table of Contents

Altria Group, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Earnings

(in millions of dollars)

(Unaudited)

 

     For the Three Months Ended March 31,  
     2012      2011  

Net earnings

   $ 973       $ 938   

Other comprehensive earnings, net of deferred income taxes:

     

Benefit plans:

     

Amounts reclassified to net earnings

     22         32   

SABMiller:

     

Ownership share of SABMiller’s other comprehensive earnings before reclassifications to net earnings

     177         57   

Amounts reclassified to net earnings

     3         4   
  

 

 

    

 

 

 
     180         61   
  

 

 

    

 

 

 

Other comprehensive earnings, net of deferred income taxes

     202         93   
  

 

 

    

 

 

 

Comprehensive earnings

     1,175         1,031   

Comprehensive earnings attributable to noncontrolling interests

        (1
  

 

 

    

 

 

 

Comprehensive earnings attributable to Altria Group, Inc.

   $ 1,175       $ 1,030   
  

 

 

    

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

Altria Group, Inc. and Subsidiaries

Condensed Consolidated Statements of Stockholders’ Equity

for the Year Ended December 31, 2011 and

the Three Months Ended March 31, 2012

(in millions of dollars, except per share data)

(Unaudited)

 

     Attributable to Altria Group, Inc.              
     Common
Stock
     Additional
Paid-in
Capital
    Earnings
Reinvested
in the
Business
    Accumulated
Other
Comprehensive
Losses
    Cost of
Repurchased
Stock
    Non-
controlling
Interests
    Total
Stockholders’
Equity
 

Balances, December 31, 2010

   $ 935       $ 5,751      $ 23,459      $ (1,484   $ (23,469   $ 3      $ 5,195   

Net earnings

          3,390            1        3,391   

Other comprehensive losses, net of deferred tax benefit

            (403         (403

Exercise of stock options and other stock award activity

        (77         171          94   

Cash dividends declared ($1.58 per share)

          (3,266           (3,266

Repurchases of common stock

              (1,327       (1,327

Other

                (1     (1
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances, December 31, 2011

     935         5,674        23,583        (1,887     (24,625     3        3,683   

Net earnings

          973              973   

Other comprehensive earnings, net of deferred income taxes

            202            202   

Exercise of stock options and other stock award activity

        (41         17          (24

Cash dividends declared ($0.41 per share)

          (836           (836

Repurchases of common stock

              (294       (294
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances, March 31, 2012

   $ 935       $ 5,633      $ 23,720      $ (1,685   $ (24,902   $ 3      $ 3,704   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

-7-


Table of Contents

Altria Group, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(in millions of dollars)

(Unaudited)

 

     For the Three Months Ended March 31,  
     2012     2011  

CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES

    

Net earnings - Consumer products

   $ 949      $ 925   

  - Financial services

     24        13   
  

 

 

   

 

 

 

Net earnings

     973        938   

Adjustments to reconcile net earnings to operating cash flows:

    

Consumer products

    

Depreciation and amortization

     56        60   

Deferred income tax provision

     80        72   

Earnings from equity investment in SABMiller

     (178     (189

Asset impairment and exit costs, net of cash paid

     (14     (16

Cash effects of changes:

    

Receivables, net

     13        (5

Inventories

     (51     (21

Accounts payable

     (68     (66

Income taxes

     421        396   

Accrued liabilities and other current assets

     7        (96

Accrued settlement charges

     1,025        1,033   

Pension plan contributions

     (504     (204

Pension provisions and postretirement, net

     31        63   

Other

     37        70   

Financial services

    

Deferred income tax benefit

     (297     (110

Other

     306        137   
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,837        2,062   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

Continued

 

-8-


Table of Contents

Altria Group, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Continued)

(in millions of dollars)

(Unaudited)

 

     For the Three Months Ended March 31,  
     2012     2011  

CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES

    

Consumer products

    

Capital expenditures

   $ (16   $ (13

Other

       1   

Financial services

    

Proceeds from finance assets

     303        4   
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     287        (8
  

 

 

   

 

 

 

CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES

    

Repurchases of common stock

     (266  

Dividends paid on common stock

     (838     (794

Issuances of common stock

       21   

Other

     (134     (163
  

 

 

   

 

 

 

Net cash used in financing activities

     (1,238     (936
  

 

 

   

 

 

 

Cash and cash equivalents:

    

Increase

     886        1,118   

Balance at beginning of period

     3,270        2,314   
  

 

 

   

 

 

 

Balance at end of period

   $ 4,156      $ 3,432   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1. Background and Basis of Presentation:

Background

At March 31, 2012, Altria Group, Inc.’s direct and indirect wholly-owned subsidiaries included Philip Morris USA Inc. (“PM USA”), which is engaged in the manufacture and sale of cigarettes and certain smokeless products in the United States; John Middleton Co. (“Middleton”), which is engaged in the manufacture and sale of machine-made large cigars and pipe tobacco, and is a wholly-owned subsidiary of PM USA; and UST LLC (“UST”), which through its direct and indirect wholly-owned subsidiaries including U.S. Smokeless Tobacco Company LLC (“USSTC”) and Ste. Michelle Wine Estates Ltd. (“Ste. Michelle”), is engaged in the manufacture and sale of smokeless products and wine. Philip Morris Capital Corporation (“PMCC”), another wholly-owned subsidiary of Altria Group, Inc., maintains a portfolio of leveraged and direct finance leases. In addition, Altria Group, Inc. held a 27.0% economic and voting interest in SABMiller plc (“SABMiller”) at March 31, 2012, which is accounted for under the equity method of accounting. Altria Group, Inc.’s access to the operating cash flows of its wholly-owned subsidiaries consists of cash received from the payment of dividends and distributions, and the payment of interest on intercompany loans by its subsidiaries. In addition, Altria Group, Inc. receives cash dividends on its interest in SABMiller, if and when SABMiller pays such dividends. At March 31, 2012, Altria Group, Inc.’s principal wholly-owned subsidiaries were not limited by long-term debt or other agreements in their ability to pay cash dividends or make other distributions with respect to their common stock.

Share Repurchases

In October 2011, Altria Group, Inc.’s Board of Directors authorized a $1.0 billion share repurchase program, which Altria Group, Inc. intends to complete by the end of 2012. During the first quarter of 2012, Altria Group, Inc. repurchased 9.9 million shares of its common stock under this share repurchase program at an aggregate cost of approximately $294 million and an average price of $29.71 per share. As of March 31, 2012, Altria Group, Inc. repurchased a total of 21.7 million shares of its common stock under this program at an aggregate cost of $622 million, and an average price of $28.70 per share. The timing of share repurchases under this program depends upon marketplace conditions and other factors, and the program remains subject to the discretion of Altria Group, Inc.’s Board of Directors.

Basis of Presentation

The interim condensed consolidated financial statements of Altria Group, Inc. are unaudited. It is the opinion of Altria Group, Inc.’s management that all adjustments necessary for a fair statement of the interim results presented have been reflected therein. All such adjustments were of a normal recurring nature. Net revenues and net earnings for any interim period are not necessarily indicative of results that may be expected for the entire year.

These statements should be read in conjunction with the consolidated financial statements and related notes, which appear in Altria Group, Inc.’s Annual Report to Shareholders and which are incorporated by reference into Altria Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2011.

Balance sheet accounts are segregated by two broad types of businesses. Consumer products assets and liabilities are classified as either current or non-current, whereas financial services assets and liabilities are unclassified, in accordance with respective industry practices.

Altria Group, Inc.’s chief operating decision maker has been evaluating the operating results of the former cigarettes and cigars segments as a single smokeable products segment since January 1, 2012. The combination of these two formerly separate segments is related to the restructuring associated with a cost reduction program announced in October 2011 (the “2011 Cost Reduction Program”). Also, in connection with the 2011 Cost Reduction Program, effective January 1, 2012, Middleton became a wholly-owned subsidiary of PM USA, reflecting management’s goal to achieve efficiencies in the management of these businesses. Effective with the first quarter of 2012, Altria Group, Inc.’s reportable segments are smokeable products, smokeless products, wine and financial services. For further discussion on the 2011 Cost Reduction Program, see Note 2. Asset Impairment, Exit and Implementation Costs.

Effective January 1, 2012, Altria Group, Inc. adopted new authoritative accounting guidance that eliminated the option of presenting components of other comprehensive earnings as part of the statement of stockholders’ equity. With the

 

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Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

adoption of this guidance, Altria Group, Inc. is reporting other comprehensive earnings in a separate statement immediately following the statement of earnings.

Note 2. Asset Impairment, Exit and Implementation Costs:

Pre-tax asset impairment, exit and implementation costs for the three months ended March 31, 2012 consisted of the following:

 

     For the Three Months Ended March 31, 2012  
     Asset
Impairment
and Exit
Costs
     Implementation
(Gain) Costs
    Total  
            (in millions)        

Smokeable products

   $ 7       $ (21   $ (14

Smokeless products

     14         5        19   

General corporate

        (1     (1
  

 

 

    

 

 

   

 

 

 

Total

   $ 21       $ (17   $ 4   
  

 

 

    

 

 

   

 

 

 

The asset impairment, exit and implementation costs shown in the table above are related to the 2011 Cost Reduction Program, which is discussed further below.

For the three months ended March 31, 2011, total pre-tax asset impairment and exit costs were $2 million, all of which were reported in the smokeable products segment. There were no implementation costs incurred during the three months ended March 31, 2011.

The movement in the severance liability and details of asset impairment and exit costs for Altria Group, Inc. for the three months ended March 31, 2012 were as follows:

 

00000000 00000000 00000000
     Severance     Other     Total  
           (in millions)        

Severance liability balance, December 31, 2011

   $ 156      $ —        $ 156   

Charges

       21        21   

Cash spent

     (25     (10     (35

Other

       (11     (11
  

 

 

   

 

 

   

 

 

 

Severance liability balance, March 31, 2012

   $ 131      $ —        $ 131   
  

 

 

   

 

 

   

 

 

 

2011 Cost Reduction Program: In October 2011, Altria Group, Inc. announced a new cost reduction program for its tobacco and service company subsidiaries, reflecting Altria Group, Inc.’s objective to reduce cigarette-related infrastructure ahead of PM USA’s cigarettes volume declines. As a result of this program, Altria Group, Inc. expects to incur total net pre-tax charges of approximately $300 million (concluding in 2012). The estimated net charges include employee separation costs of approximately $220 million and other net charges of approximately $80 million. These other net charges include lease termination and asset impairments, partially offset by a curtailment gain related to amendments made to an Altria Group, Inc. postretirement benefit plan. Substantially all of these charges will result in cash expenditures.

Implementation (gain) costs of ($17) million shown in the table above were recorded on Altria Group, Inc.’s condensed consolidated statement of earnings for the three months ended March 31, 2012, as follows: a net gain of $25 million, which included a $26 million curtailment gain related to amendments made to an Altria Group, Inc. postretirement benefit plan, was included in marketing, administration and research costs; and other costs of $8 million were included in cost of sales.

Total pre-tax charges, net incurred since the inception of this program through March 31, 2012 were $228 million. Cash payments related to this program of $32 million were made during the three months ended March 31, 2012, for total cash payments of $41 million since inception.

 

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Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

In connection with the 2011 Cost Reduction Program, Altria Group, Inc. has reorganized two of its tobacco operating companies and revised its reportable segments (see Note 1. Background and Basis of Presentation and Note 7. Segment Reporting).

Note 3. Benefit Plans:

Subsidiaries of Altria Group, Inc. sponsor noncontributory defined benefit pension plans covering the majority of all employees of Altria Group, Inc. However, employees hired on or after a date specific to their employee group are not eligible to participate in noncontributory defined benefit pension plans but are instead eligible to participate in a defined contribution plan with enhanced benefits. This transition for new hires occurred from October 1, 2006 to January 1, 2008. In addition, effective January 1, 2010, certain employees of UST and Middleton who were participants in noncontributory defined benefit pension plans ceased to earn additional benefit service under those plans and became eligible to participate in a defined contribution plan with enhanced benefits. Altria Group, Inc. and its subsidiaries also provide health care and other benefits to the majority of retired employees.

Pension Plans

Components of Net Periodic Benefit Cost

Net periodic pension cost consisted of the following:

 

     For the Three Months Ended March 31,  
     2012     2011  
     (in millions)  

Service cost

   $ 20      $ 19   

Interest cost

     86        87   

Expected return on plan assets

     (111     (106

Amortization:

    

Net loss

     56        43   

Prior service cost

     3        4   
  

 

 

   

 

 

 

Net periodic pension cost

   $ 54      $ 47   
  

 

 

   

 

 

 

Employer Contributions

Altria Group, Inc. makes contributions to the extent that they are tax deductible and to pay benefits that relate to plans for salaried employees that cannot be funded under Internal Revenue Service (“IRS”) regulations. On January 3, 2012, Altria Group, Inc. made a voluntary $500 million contribution to its pension plans. Additional employer contributions of $4 million were made to Altria Group, Inc.’s pension plans during the three months ended March 31, 2012. Currently, Altria Group, Inc. anticipates making additional employer contributions to its pension plans of approximately $30 million to $50 million during the remainder of 2012, based on current tax law. However, this estimate is subject to change as a result of changes in tax and other benefit laws, as well as asset performance significantly above or below the assumed long-term rate of return on pension assets, or changes in interest rates.

 

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Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Postretirement Benefit Plans

Net postretirement health care costs consisted of the following:

 

     For the Three Months Ended March 31,  
     2012     2011  
     (in millions)  

Service cost

   $ 5      $ 9   

Interest cost

     30        34   

Amortization:

    

Net loss

     12        9   

Prior service credit

     (11     (5

Curtailment gain

     (26  
  

 

 

   

 

 

 

Net postretirement health care costs

   $ 10      $ 47   
  

 

 

   

 

 

 

The curtailment gain shown in the table above is related to the 2011 Cost Reduction Program. For further information on this program, see Note 2. Asset Impairment, Exit and Implementation Costs.

Note 4. Earnings from Equity Investment in SABMiller:

Pre-tax earnings from Altria Group, Inc.’s equity investment in SABMiller consisted of the following:

 

     For the Three Months Ended March 31,  
     2012      2011  
     (in millions)  

Equity earnings

   $ 166       $ 185   

Gains resulting from issuances of common stock by SABMiller

     12         4   
  

 

 

    

 

 

 
   $ 178       $ 189   
  

 

 

    

 

 

 

Note 5. Earnings per Share:

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

 

     For the Three Months Ended March 31,  
     2012     2011  
     (in millions)  

Net earnings attributable to Altria Group, Inc.

   $ 973      $ 937   

Less: Distributed and undistributed earnings attributable to unvested restricted and deferred shares

     (3     (4
  

 

 

   

 

 

 

Earnings for basic and diluted EPS

   $ 970      $ 933   
  

 

 

   

 

 

 

Weighted-average shares for basic and diluted EPS

     2,034        2,084   
  

 

 

   

 

 

 

There were no stock options remaining at March 31, 2012. For the three months ended March 31, 2012 and 2011 computations, there were no antidilutive stock options.

 

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Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 6. Other Comprehensive Earnings/Losses:

The following table sets forth the changes in each component of accumulated other comprehensive losses, net of deferred income taxes, attributable to Altria Group, Inc.:

 

00000000 00000000 00000000 00000000
     Currency
Translation
Adjustments
    Benefit Plans     SABMiller     Accumulated
Other
Comprehensive
Losses
 
     (in millions)  

Balances, December 31, 2010

   $ 4      $ (1,811   $ 323      $ (1,484

Period change

     (2     (251     (150     (403
  

 

 

   

 

 

   

 

 

   

 

 

 

Balances, December 31, 2011

     2        (2,062     173        (1,887

Period change

       22        180        202   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balances, March 31, 2012

   $ 2      $ (2,040   $ 353      $ (1,685
  

 

 

   

 

 

   

 

 

   

 

 

 

The following table sets forth deferred income tax expense for the components of other comprehensive earnings for the three months ended March 31, 2012 and 2011:

 

00000000 00000000 00000000 00000000
     Currency
Translation
Adjustments
     Benefit Plans      SABMiller      Total  
     (in millions)  

Three months ended March 31, 2012

   $ —         $ 15       $ 97       $ 112   

Three months ended March 31, 2011

   $ —         $ 21       $ 32       $ 53   

Note 7. Segment Reporting:

The products of Altria Group, Inc.’s consumer products subsidiaries include smokeable products comprised of cigarettes manufactured and sold by PM USA, and machine-made large cigars and pipe tobacco manufactured and sold by Middleton; smokeless products manufactured and sold by or on behalf of USSTC and PM USA; and wine produced and/or distributed by Ste. Michelle. Another subsidiary of Altria Group, Inc., PMCC, maintains a portfolio of leveraged and direct finance leases. The products and services of these subsidiaries constitute Altria Group, Inc.’s reportable segments of smokeable products, smokeless products, wine and financial services.

As discussed in Note 1. Background and Basis of Presentation, beginning with the first quarter of 2012, Altria Group, Inc. has revised its reportable segments. Prior-period segment data have been recast to conform with the current-period segment presentation.

Altria Group, Inc.’s chief operating decision maker reviews operating companies income to evaluate the performance of and allocate resources to the segments. Operating companies income for the segments excludes general corporate expenses and amortization of intangibles. Interest and other debt expense, net (consumer products), and provision for income taxes are centrally managed at the corporate level and, accordingly, such items are not presented by segment since they are excluded from the measure of segment profitability reviewed by Altria Group, Inc.’s chief operating decision maker.

 

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Segment data were as follows:

 

     For the Three Months Ended March 31,  
     2012     2011  
     (in millions)  

Net revenues:

    

Smokeable products

   $ 5,100      $ 5,143   

Smokeless products

     380        379   

Wine

     113        101   

Financial services

     54        20   
  

 

 

   

 

 

 

Net revenues

   $ 5,647      $ 5,643   
  

 

 

   

 

 

 

Earnings before income taxes:

    

Operating companies income:

    

Smokeable products

   $ 1,439      $ 1,369   

Smokeless products

     192        193   

Wine

     15        12   

Financial services

     52        21   

Amortization of intangibles

     (5     (6

General corporate expenses

     (51     (50
  

 

 

   

 

 

 

Operating income

     1,642        1,539   

Interest and other debt expense, net

     (293     (278

Earnings from equity investment in SABMiller

     178        189   
  

 

 

   

 

 

 

Earnings before income taxes

   $ 1,527      $ 1,450   
  

 

 

   

 

 

 

See Note 2. Asset Impairment, Exit and Implementation Costs for a breakdown of asset impairment, exit and implementation costs by segment, which affect the comparability of operating companies income for the segments.

Note 8. Finance Assets, net:

At March 31, 2012, finance assets, net, of $3,247 million were comprised of investments in finance leases of $3,392 million and an other receivable of $59 million, reduced by the allowance for losses of $204 million. At December 31, 2011, finance assets, net, of $3,559 million were comprised of investments in finance leases of $3,786 million, reduced by the allowance for losses of $227 million.

PMCC assesses the adequacy of its allowance for losses relative to the credit risk of its leasing portfolio on an ongoing basis. PMCC believes that, as of March 31, 2012, the allowance for losses of $204 million is adequate. PMCC continues to monitor economic and credit conditions, and the individual situations of its lessees and their respective industries, and may have to increase its allowance for losses if such conditions worsen.

The activity in the allowance for losses on finance assets for the three months ended March 31, 2012 and 2011 was as follows:

 

     For the Three Months Ended March 31,  
     2012     2011  
     (in millions)   

Balance at beginning of year

   $ 227      $ 202   

Amounts written-off

     (23  
  

 

 

   

 

 

 

Balance at March 31

   $ 204      $ 202   
  

 

 

   

 

 

 

 

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Notes to Condensed Consolidated Financial Statements

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PMCC leases 28 aircraft to American Airlines, Inc. (“American”), which filed for bankruptcy on November 29, 2011. As of the date of the bankruptcy filing, PMCC stopped recording income on its $140 million investment in finance leases from American. On February 10, 2012, American filed a motion to reject the leases for nine of the 28 aircraft under lease, which resulted in a $23 million write-off of the related investment in finance lease balance against PMCC’s allowance for losses. The remaining leases could be rejected, restructured or, where applicable, foreclosed upon by the debtholders, which would result in a write-off of the related investment in finance lease balance against PMCC’s allowance for losses. Should foreclosure occur, PMCC would be subject to an acceleration of deferred taxes of approximately $22 million.

With the exception of American, all PMCC lessees were current on their lease payment obligations as of March 31, 2012.

The credit quality of PMCC’s investments in finance assets as assigned by Standard & Poor’s Ratings Services (“Standard & Poor’s”) and Moody’s Investors Service, Inc. (“Moody’s”) at March 31, 2012 and December 31, 2011 was as follows:

 

    

March 31, 2012

    

December 31, 2011

 
     (in millions)  

Credit Rating by Standard & Poor's/Moody's

     

“AAA/Aaa” to “A-/A3”

   $ 1,373       $ 1,570   

“BBB+/Baa1” to “BBB-/Baa3”

     1,029         1,080   

“BB+/Ba1” and Lower

     1,049         1,136   
  

 

 

    

 

 

 

Total

   $ 3,451       $ 3,786   
  

 

 

    

 

 

 

See Note 10. Contingencies for a discussion of the IRS’s disallowance of certain tax benefits pertaining to several PMCC leveraged lease transactions.

Note 9. Debt:

At March 31, 2012 and December 31, 2011 Altria Group, Inc. had no short-term borrowings.

Altria Group, Inc.’s estimate of the fair value of its debt is based on observable market information from a third party pricing source and is classified in level 2 of the fair value hierarchy. The aggregate fair value of Altria Group, Inc.’s total long-term debt at March 31, 2012 and December 31, 2011, was $17.7 billion, as compared with its carrying value of $13.7 billion.

Note 10. Contingencies:

Legal proceedings covering a wide range of matters are pending or threatened in various United States and foreign jurisdictions against Altria Group, Inc. and its subsidiaries, including PM USA and UST and its subsidiaries, as well as their respective indemnitees. Various types of claims are raised in these proceedings, including product liability, consumer protection, antitrust, tax, contraband shipments, patent infringement, employment matters, claims for contribution and claims of distributors.

Litigation is subject to uncertainty and it is possible that there could be adverse developments in pending or future cases. An unfavorable outcome or settlement of pending tobacco-related or other litigation could encourage the commencement of additional litigation. Damages claimed in some tobacco-related and other litigation are or can be significant and, in certain cases, range in the billions of dollars. The variability in pleadings in multiple jurisdictions, together with the actual experience of management in litigating claims, demonstrate that the monetary relief that may be specified in a lawsuit bears little relevance to the ultimate outcome. In certain cases, plaintiffs claim that defendants’ liability is joint and several. In such cases, Altria Group, Inc. or its subsidiaries may face the risk that one or more co-defendants decline or otherwise fail to participate in the bonding required for an appeal or to pay their proportionate or jury-allocated share of a judgment. As a result, Altria Group, Inc. or its subsidiaries under certain circumstances may have to pay more than their proportionate share of any bonding- or judgment-related amounts.

 

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Notes to Condensed Consolidated Financial Statements

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Although PM USA has historically been able to obtain required bonds or relief from bonding requirements in order to prevent plaintiffs from seeking to collect judgments while adverse verdicts have been appealed, there remains a risk that such relief may not be obtainable in all cases. This risk has been substantially reduced given that 45 states now limit the dollar amount of bonds or require no bond at all. As discussed below, however, tobacco litigation plaintiffs have challenged the constitutionality of Florida’s bond cap statute in several cases and plaintiffs may challenge state bond cap statutes in other jurisdictions as well. Such challenges may include the applicability of state bond caps in federal court. Although we cannot predict the outcome of such challenges, it is possible that the consolidated results of operations, cash flows or financial position of Altria Group, Inc., or one or more of its subsidiaries, could be materially affected in a particular fiscal quarter or fiscal year by an unfavorable outcome of one or more such challenges.

Altria Group, Inc. and its subsidiaries record provisions in the condensed consolidated financial statements for pending litigation when they determine that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. At the present time, while it is reasonably possible that an unfavorable outcome in a case may occur, except as discussed elsewhere in this Note 10. Contingencies: (i) management has concluded that it is not probable that a loss has been incurred in any of the pending tobacco-related cases; (ii) management is unable to estimate the possible loss or range of loss that could result from an unfavorable outcome in any of the pending tobacco-related cases; and (iii) accordingly, management has not provided any amounts in the condensed consolidated financial statements for unfavorable outcomes, if any. Legal defense costs are expensed as incurred.

Altria Group, Inc. and its subsidiaries have achieved substantial success in managing litigation. Nevertheless, litigation is subject to uncertainty and significant challenges remain. It is possible that the consolidated results of operations, cash flows or financial position of Altria Group, Inc., or one or more of its subsidiaries, could be materially affected in a particular fiscal quarter or fiscal year by an unfavorable outcome or settlement of certain pending litigation. Altria Group, Inc. and each of its subsidiaries named as a defendant believe, and each has been so advised by counsel handling the respective cases, that it has valid defenses to the litigation pending against it, as well as valid bases for appeal of adverse verdicts. Each of the companies has defended, and will continue to defend, vigorously against litigation challenges. However, Altria Group, Inc. and its subsidiaries may enter into settlement discussions in particular cases if they believe it is in the best interests of Altria Group, Inc. to do so.

Overview of Altria Group, Inc. and/or PM USA Tobacco-Related Litigation

Types and Number of Cases

Claims related to tobacco products generally fall within the following categories: (i) smoking and health cases alleging personal injury brought on behalf of individual plaintiffs; (ii) smoking and health cases primarily alleging personal injury or seeking court-supervised programs for ongoing medical monitoring and purporting to be brought on behalf of a class of individual plaintiffs, including cases in which the aggregated claims of a number of individual plaintiffs are to be tried in a single proceeding; (iii) health care cost recovery cases brought by governmental (both domestic and foreign) and non-governmental plaintiffs seeking reimbursement for health care expenditures allegedly caused by cigarette smoking and/or disgorgement of profits; (iv) class action suits alleging that the uses of the terms “Lights” and “Ultra Lights” constitute deceptive and unfair trade practices, common law fraud, or violations of the Racketeer Influenced and Corrupt Organizations Act (“RICO”); and (v) other tobacco-related litigation described below. Plaintiffs’ theories of recovery and the defenses raised in pending smoking and health, health care cost recovery and “Lights/Ultra Lights” cases are discussed below.

 

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Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The table below lists the number of certain tobacco-related cases pending in the United States against PM USA and, in some instances, Altria Group, Inc. as of April 23, 2012, April 25, 2011 and April 26, 2010.

 

Type of Case    Number of Cases
Pending as  of
April 23, 2012
     Number of Cases
Pending as of
April 25, 2011
     Number of Cases
Pending as of
April 26, 2010
 

Individual Smoking and Health Cases (1)

     79         89         85   

Smoking and Health Class Actions and Aggregated Claims Litigation (2)

     7         10         7   

Health Care Cost Recovery Actions

     1         3         3   

“Lights/Ultra Lights” Class Actions

     17         30         28   

Tobacco Price Cases

     1         1         2   

 

(1) Does not include 2,585 cases brought by flight attendants seeking compensatory damages for personal injuries allegedly caused by exposure to environmental tobacco smoke (“ETS”). The flight attendants allege that they are members of an ETS smoking and health class action in Florida, which was settled in 1997 (Broin). The terms of the court-approved settlement in that case allow class members to file individual lawsuits seeking compensatory damages, but prohibit them from seeking punitive damages. Certain Broin plaintiffs have filed a motion seeking approximately $50 million in sanctions for alleged interference by R.J. Reynolds Tobacco Company (“R.J. Reynolds”) and PM USA with Lorillard, Inc.’s acceptance of offers of settlement in the Broin progeny cases. In May 2011, the trial court denied this motion. On January 5, 2012, the Florida Third District Court of Appeal denied plaintiffs’ petition for a writ of certiorari seeking immediate review and, on March 6, 2012, the court denied plaintiffs’ petition for rehearing.

Also, does not include approximately 6,540 individual smoking and health cases (3,298 state court cases and 3,242 federal court cases) brought by or on behalf of approximately 7,791 plaintiffs in Florida (4,550 state court plaintiffs and 3,241 federal court plaintiffs) following the decertification of the Engle case discussed below. It is possible that some of these cases are duplicates and that additional cases have been filed but not yet recorded on the courts’ dockets.

 

(2) Includes as one case the 600 civil actions (of which 346 are actions against PM USA) that are to be tried in a single proceeding in West Virginia (In re: Tobacco Litigation). The West Virginia Supreme Court of Appeals has ruled that the United States Constitution does not preclude a trial in two phases in this case. Under the current trial plan, issues related to defendants’ conduct and whether punitive damages are permissible will be tried in the first phase. The second phase would consist of individual trials to determine liability, if any, as well as compensatory and punitive damages, if any. Trial in the case began in October 2011, but ended in a mistrial in November 2011. The court has not yet scheduled a new trial.

International Tobacco-Related Cases

As of April 23, 2012, PM USA is a named defendant in Israel in one “Lights” class action. PM USA is a named defendant in four health care cost recovery actions in Canada, three of which also name Altria Group, Inc. as a defendant. PM USA and Altria Group, Inc. are also named defendants in six smoking and health class actions filed in various Canadian provinces. See Guarantees for a discussion of the Distribution Agreement between Altria Group, Inc. and Philip Morris International Inc. (“PMI”) that provides for indemnities for certain liabilities concerning tobacco products.

Pending and Upcoming Tobacco-Related Trials

As of April 23, 2012, 36 Engle progeny cases and 3 individual smoking and health cases against PM USA are set for trial in 2012. Cases against other companies in the tobacco industry are also scheduled for trial in 2012. Trial dates are subject to change.

 

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Notes to Condensed Consolidated Financial Statements

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Trial Results

Since January 1999, excluding the Engle progeny cases (separately discussed below), verdicts have been returned in 51 smoking and health, “Lights/Ultra Lights” and health care cost recovery cases in which PM USA was a defendant. Verdicts in favor of PM USA and other defendants were returned in 34 of the 51 cases. These 34 cases were tried in Alaska (1), California (5), Florida (9), Louisiana (1), Massachusetts (1), Mississippi (1), Missouri (3), New Hampshire (1), New Jersey (1), New York (4), Ohio (2), Pennsylvania (1), Rhode Island (1), Tennessee (2), and West Virginia (1). A motion for a new trial was granted in one of the cases in Florida.

Of the 17 non-Engle progeny cases in which verdicts were returned in favor of plaintiffs, fifteen have reached final resolution. A verdict against defendants in one health care cost recovery case (Blue Cross/Blue Shield) was reversed and all claims were dismissed with prejudice. In addition, a verdict against defendants in a purported “Lights” class action in Illinois (Price) was reversed and the case was dismissed with prejudice in December 2006. In December 2008, the plaintiff in Price filed a motion with the state trial court to vacate the judgment dismissing this case in light of the United States Supreme Court’s decision in Good (see below for a discussion of developments in Good and Price).

As of April 23, 2012, twenty-nine Engle progeny cases involving PM USA have resulted in verdicts since the Florida Supreme Court’s Engle decision. Fourteen verdicts were returned in favor of plaintiffs and fifteen verdicts were returned in favor of PM USA. See Smoking and Health Litigation – Engle Progeny Trial Results below for a discussion of these verdicts.

After exhausting all appeals in those cases resulting in adverse verdicts (Engle progeny and non-Engle progeny), PM USA has paid judgments (and related costs and fees) totaling approximately $240 million and interest totaling approximately $139 million as of April 23, 2012.

Security for Judgments

To obtain stays of judgments pending current appeals, as of March 31, 2012, PM USA has posted various forms of security totaling approximately $49 million, the majority of which has been collateralized with cash deposits that are included in other assets on the condensed consolidated balance sheets.

Smoking and Health Litigation

Overview

Plaintiffs’ allegations of liability in smoking and health cases are based on various theories of recovery, including negligence, gross negligence, strict liability, fraud, misrepresentation, design defect, failure to warn, nuisance, breach of express and implied warranties, breach of special duty, conspiracy, concert of action, violations of deceptive trade practice laws and consumer protection statutes, and claims under the federal and state anti-racketeering statutes. Plaintiffs in the smoking and health actions seek various forms of relief, including compensatory and punitive damages, treble/multiple damages and other statutory damages and penalties, creation of medical monitoring and smoking cessation funds, disgorgement of profits, and injunctive and equitable relief. Defenses raised in these cases include lack of proximate cause, assumption of the risk, comparative fault and/or contributory negligence, statutes of limitations and preemption by the Federal Cigarette Labeling and Advertising Act.

Non-Engle Progeny Trial Results

Summarized below are the non-Engle progeny smoking and health cases that were pending during 2012 in which verdicts were returned in favor of plaintiffs. A chart listing the verdicts for plaintiffs in the Engle progeny cases can be found in Smoking and Health Litigation – Engle Progeny Trial Results below.

D. Boeken: In August 2011, a California jury returned a verdict in favor of plaintiff, awarding $12.8 million in compensatory damages against PM USA. PM USA’s motions for judgment notwithstanding the verdict and for a new trial were denied in October 2011. PM USA has filed a notice of appeal, and posted a bond in the amount of $12.8 million in November 2011.

 

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Notes to Condensed Consolidated Financial Statements

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Bullock: In October 2002, a California jury awarded against PM USA $850,000 in compensatory damages and $28 billion in punitive damages. In December 2002, the trial court reduced the punitive damages award to $28 million. In April 2006, the California Court of Appeal affirmed the $28 million punitive damages award. In August 2006, the California Supreme Court denied plaintiffs’ petition to overturn the trial court’s reduction of the punitive damages award and granted PM USA’s petition for review challenging the punitive damages award. In May 2007, the California Supreme Court remanded the case to the Second District of the California Court of Appeal with directions that the court vacate its 2006 decision and reconsider the case in light of the United States Supreme Court’s decision in the Williams case discussed below. In January 2008, the California Court of Appeal reversed the judgment with respect to the $28 million punitive damages award, affirmed the judgment in all other respects, and remanded the case to the trial court to conduct a new trial on the amount of punitive damages. In July 2008, $43.3 million of escrow funds were returned to PM USA. In August 2009, the jury returned a verdict, and in December 2009, the trial court entered a judgment, awarding plaintiffs $13.8 million in punitive damages, plus costs. In August 2011, the California Court of Appeal affirmed the final judgment entered in favor of the plaintiffs. In November 2011, the California Supreme Court denied PM USA’s petition for review. In the fourth quarter of 2011, PM USA recorded a pre-tax provision of $14 million related to damages and costs and $3 million related to interest. On March 1, 2012, PM USA paid an amount of approximately $19.1 million in satisfaction of the judgment and associated costs and interest. This litigation has concluded.

Schwarz: In March 2002, an Oregon jury awarded against PM USA $168,500 in compensatory damages and $150 million in punitive damages. In May 2002, the trial court reduced the punitive damages award to $100 million. In October 2002, PM USA posted an appeal bond of approximately $58.3 million. In May 2006, the Oregon Court of Appeals affirmed the compensatory damages verdict, reversed the award of punitive damages and remanded the case to the trial court for a second trial to determine the amount of punitive damages, if any. In June 2006, plaintiff petitioned the Oregon Supreme Court to review the portion of the court of appeals’ decision reversing and remanding the case for a new trial on punitive damages. In June 2010, the Oregon Supreme Court affirmed the court of appeals’ decision and remanded the case to the trial court for a new trial limited to the question of punitive damages. In December 2010, the Oregon Supreme Court reaffirmed its earlier ruling and awarded PM USA approximately $500,000 in costs. In January 2011, the trial court issued an order releasing PM USA’s appeal bond. In March 2011, PM USA filed a claim against the plaintiff for its costs and disbursements on appeal, plus interest. Trial on the amount of punitive damages began in January 2012. On February 16, 2012, the jury awarded plaintiff $25 million in punitive damages. On March 16, 2012, PM USA filed motions to set aside the verdict, for a new trial or, in the alternative, for a remittitur. Argument is set for May 17, 2012.

Williams: In March of 1999, an Oregon jury awarded against PM USA $800,000 in compensatory damages (capped statutorily at $500,000), $21,500 in medical expenses, and $79.5 million in punitive damages. The trial court reduced the punitive damages award to approximately $32 million, and PM USA and plaintiff appealed. In June 2002, the Oregon Court of Appeals reinstated the $79.5 million punitive damages award. In October 2003, the United States Supreme Court set aside the Oregon appellate court’s ruling and directed the Oregon court to reconsider the case in light of the 2003 State Farm decision by the United States Supreme Court, which limited punitive damages. In June 2004, the Oregon Court of Appeals reinstated the $79.5 million punitive damages award. In February 2006, the Oregon Supreme Court affirmed the Court of Appeals’ decision. The United States Supreme Court granted PM USA’s petition for writ of certiorari in May 2006. In February 2007, the United States Supreme Court vacated the $79.5 million punitive damages award and remanded the case to the Oregon Supreme Court for further proceedings consistent with its decision. In January 2008, the Oregon Supreme Court affirmed the Oregon Court of Appeals’ June 2004 decision, which in turn, upheld the jury’s compensatory damages award and reinstated the jury’s award of $79.5 million in punitive damages. After the United States Supreme Court declined to issue a writ of certiorari, PM USA paid $61.1 million to the plaintiff, representing the compensatory damages award, forty percent of the punitive damages award and accrued interest. Although Oregon state law requires that sixty percent of any punitive damages award be paid to the state, the Oregon trial court ruled in February 2010 that, as a result of the Master Settlement Agreement (“MSA”), the state is not entitled to collect its sixty percent share of the punitive damages award. In June 2010, the trial court further held that, under the Oregon statute, PM USA is not required to pay the sixty percent share to plaintiff. Both the plaintiff in Williams and the state appealed these rulings to the Oregon Court of Appeals. In December 2010, on its own motion, the Oregon Court of Appeals certified the appeals to the Oregon Supreme Court, and the Oregon Supreme Court accepted certification. In December 2011, the Oregon Supreme Court reversed the trial court and ruled that PM USA was required to pay the state the sixty percent portion of the punitive damages award. PM USA’s petition for rehearing before the Oregon Supreme Court was denied in January 2012. In the fourth quarter of 2011, PM USA recorded a pre-tax provision of approximately $48 million related to damages and costs and $54 million related to

 

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Notes to Condensed Consolidated Financial Statements

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interest. In January 2012, PM USA paid an amount of approximately $102 million in satisfaction of the judgment and associated costs and interest. This litigation has concluded.

See Scott Class Action below for a discussion of the verdict and post-trial developments in the Scott class action and Federal Government Lawsuit below for a discussion of the verdict and post-trial developments in the United States of America healthcare cost recovery case.

Engle Class Action

In July 2000, in the second phase of the Engle smoking and health class action in Florida, a jury returned a verdict assessing punitive damages totaling approximately $145 billion against various defendants, including $74 billion against PM USA. Following entry of judgment, PM USA appealed.

In May 2001, the trial court approved a stipulation providing that execution of the punitive damages component of the Engle judgment will remain stayed against PM USA and the other participating defendants through the completion of all judicial review. As a result of the stipulation, PM USA placed $500 million into an interest-bearing escrow account that, regardless of the outcome of the judicial review, was to be paid to the court and the court was to determine how to allocate or distribute it consistent with Florida Rules of Civil Procedure. In May 2003, the Florida Third District Court of Appeal reversed the judgment entered by the trial court and instructed the trial court to order the decertification of the class. Plaintiffs petitioned the Florida Supreme Court for further review.

In July 2006, the Florida Supreme Court ordered that the punitive damages award be vacated, that the class approved by the trial court be decertified, and that members of the decertified class could file individual actions against defendants within one year of issuance of the mandate. The court further declared the following Phase I findings are entitled to res judicata effect in such individual actions brought within one year of the issuance of the mandate: (i) that smoking causes various diseases; (ii) that nicotine in cigarettes is addictive; (iii) that defendants’ cigarettes were defective and unreasonably dangerous; (iv) that defendants concealed or omitted material information not otherwise known or available knowing that the material was false or misleading or failed to disclose a material fact concerning the health effects or addictive nature of smoking; (v) that defendants agreed to misrepresent information regarding the health effects or addictive nature of cigarettes with the intention of causing the public to rely on this information to their detriment; (vi) that defendants agreed to conceal or omit information regarding the health effects of cigarettes or their addictive nature with the intention that smokers would rely on the information to their detriment; (vii) that all defendants sold or supplied cigarettes that were defective; and (viii) that defendants were negligent. The court also reinstated compensatory damages awards totaling approximately $6.9 million to two individual plaintiffs and found that a third plaintiff’s claim was barred by the statute of limitations. In February 2008, PM USA paid approximately $3 million, representing its share of compensatory damages and interest, to the two individual plaintiffs identified in the Florida Supreme Court’s order.

In August 2006, PM USA sought rehearing from the Florida Supreme Court on parts of its July 2006 opinion, including the ruling (described above) that certain jury findings have res judicata effect in subsequent individual trials timely brought by Engle class members. The rehearing motion also asked, among other things, that legal errors that were raised but not expressly ruled upon in the Third District Court of Appeal or in the Florida Supreme Court now be addressed. Plaintiffs also filed a motion for rehearing in August 2006 seeking clarification of the applicability of the statute of limitations to non-members of the decertified class. In December 2006, the Florida Supreme Court refused to revise its July 2006 ruling, except that it revised the set of Phase I findings entitled to res judicata effect by excluding finding (v) listed above (relating to agreement to misrepresent information), and added the finding that defendants sold or supplied cigarettes that, at the time of sale or supply, did not conform to the representations of fact made by defendants. In January 2007, the Florida Supreme Court issued the mandate from its revised opinion. Defendants then filed a motion with the Florida Third District Court of Appeal requesting that the court address legal errors that were previously raised by defendants but have not yet been addressed either by the Third District Court of Appeal or by the Florida Supreme Court. In February 2007, the Third District Court of Appeal denied defendants’ motion. In May 2007, defendants’ motion for a partial stay of the mandate pending the completion of appellate review was denied by the Third District Court of Appeal. In May 2007, defendants filed a petition for writ of certiorari with the United States Supreme Court. In October 2007, the United States Supreme Court denied defendants’ petition. In November 2007, the United States Supreme Court denied defendants’ petition for rehearing from the denial of their petition for writ of certiorari.

 

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In February 2008, the trial court decertified the class except for purposes of the May 2001 bond stipulation, and formally vacated the punitive damages award pursuant to the Florida Supreme Court’s mandate. In April 2008, the trial court ruled that certain defendants, including PM USA, lacked standing with respect to allocation of the funds escrowed under the May 2001 bond stipulation and will receive no credit at this time from the $500 million paid by PM USA against any future punitive damages awards in cases brought by former Engle class members.

In May 2008, the trial court, among other things, decertified the limited class maintained for purposes of the May 2001 bond stipulation and, in July 2008, severed the remaining plaintiffs’ claims except for those of Howard Engle. The only remaining plaintiff in the Engle case, Howard Engle, voluntarily dismissed his claims with prejudice.

The deadline for filing Engle progeny cases, as required by the Florida Supreme Court’s decision, expired in January 2008. As of April 23, 2012, approximately 6,540 cases (3,298 state court cases and 3,242 federal court cases) were pending against PM USA or Altria Group, Inc. asserting individual claims by or on behalf of approximately 7,791 plaintiffs, (4,550 state court plaintiffs and 3,241 federal court plaintiffs). It is possible that some of these cases are duplicates. Some of these cases have been removed from various Florida state courts to the federal district courts in Florida, while others were filed in federal court.

Federal Engle Progeny Cases

Three federal district courts (in the Merlob, B. Brown and Burr cases) ruled in 2008 that the findings in the first phase of the Engle proceedings cannot be used to satisfy elements of plaintiffs’ claims, and two of those rulings (B. Brown and Burr) were certified by the trial court for interlocutory review. The certification in both cases was granted by the United States Court of Appeals for the Eleventh Circuit and the appeals were consolidated. In February 2009, the appeal in Burr was dismissed for lack of prosecution. In July 2010, the Eleventh Circuit ruled in B. Brown that, as a matter of Florida law, plaintiffs do not have an unlimited right to use the findings from the original Engle trial to meet their burden of establishing the elements of their claims at trial. The Eleventh Circuit did not reach the issue of whether the use of the Engle findings violates the defendants’ due process rights. Rather, plaintiffs may only use the findings to establish those specific facts, if any, that they demonstrate with a reasonable degree of certainty were actually decided by the original Engle jury. The Eleventh Circuit remanded the case to the district court to determine what specific factual findings the Engle jury actually made. In the Burr case, PM USA filed a motion seeking a ruling from the district court regarding the preclusive effect of the Engle findings pursuant to the Eleventh Circuit’s decision in B. Brown. In May 2011, the district court denied that motion without prejudice on procedural grounds.

In the Waggoner case, the United States District Court for the Middle District of Florida (Jacksonville) ruled in December 2011 that application of the Engle findings to establish the wrongful conduct elements of plaintiffs’ claims consistent with Martin or J. Brown did not violate defendants’ due process rights. The court ruled, however, that plaintiffs must establish legal causation to establish liability. With respect to punitive damages, the district court held that plaintiffs could rely on the findings in support of their punitive damages claims but that in addition plaintiffs must demonstrate specific conduct by specific defendants, independent of the Engle findings, that satisfies the standards for awards of punitive damages. PM USA and the other defendants sought appellate review of the due process ruling. In February 2012, the district court denied the motion for interlocutory appeal, but did apply the ruling to all active pending federal Engle progeny cases. As a result, the ruling can be appealed after an adverse verdict.

Engle progeny cases pending in the federal district courts in the Middle District of Florida asserting individual claims by or on behalf of approximately 3,200 plaintiffs remain stayed. There are currently 26 active cases pending in federal court.

In Gollihue, the first federal Engle progeny case to go to trial, the jury returned a defense verdict on February 16, 2012. On March 19, 2012, in PM USA’s second federal Engle progeny case to go to trial (McCray), the jury also returned a defense verdict.

 

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Florida Bond Cap Statute

In June 2009, Florida amended its existing bond cap statute by adding a $200 million bond cap that applies to all state Engle progeny lawsuits in the aggregate and establishes individual bond caps for individual Engle progeny cases in amounts that vary depending on the number of judgments in effect at a given time. Plaintiffs in three Engle progeny cases against R.J. Reynolds in Alachua County, Florida (Alexander, Townsend and Hall) and one case in Escambia County (Clay) have challenged the constitutionality of the bond cap statute. The Florida Attorney General has intervened in these cases in defense of the constitutionality of the statute.

Trial court rulings have been rendered in Clay, Alexander, Townsend and Hall rejecting the plaintiffs’ bond cap statute challenges in those cases. The plaintiffs have appealed these rulings. In Alexander, Clay and Hall, the District Court of Appeal for the First District of Florida affirmed the trial court decisions and certified the decision in Hall for appeal to the Florida Supreme Court, but declined to certify the question of the constitutionality of the bond cap statute in Clay and Alexander. The Florida Supreme Court has granted review of the Hall decision.

No federal court has yet to address the constitutionality of the bond cap statute or the applicability of the bond cap to Engle progeny cases tried in federal court.

Engle Progeny Trial Results

As of April 23, 2012, twenty-nine federal and state Engle progeny cases involving PM USA have resulted in verdicts since the Florida Supreme Court Engle decision. Fourteen verdicts were returned in favor of plaintiffs. For a further discussion of these cases, see the verdict chart below.

Fifteen verdicts were returned in favor of PM USA (Gelep, Kalyvas, Gil de Rubio, Warrick, Willis, Frazier, C. Campbell, Rohr, Espinosa, Oliva, Weingart, Junious, Szymanski, Gollihue and McCray). The jury in the Weingart case returned a verdict against PM USA awarding no damages, but in September 2011, the trial court granted an additur. In the Frazier case, the Florida Third District Court of Appeal reversed the judgment in defendants’ favor on April 11, 2012 and remanded the case for a new trial. In addition, there have been a number of mistrials, only some of which have resulted in new trials as of April 23, 2012.

In Lukacs, a case that was tried to verdict before the Florida Supreme Court Engle decision, the Florida Third District Court of Appeal in March 2010 affirmed per curiam the trial court decision without issuing an opinion. Under Florida procedure, further review of a per curiam affirmance without opinion by the Florida Supreme Court is generally prohibited. Subsequently in 2010, after defendants’ petition for rehearing with the Court of Appeal was denied, defendants paid the judgment.

 

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The chart below lists the verdicts and post-trial developments in the Engle progeny cases that were pending during 2012 in which verdicts were returned in favor of plaintiffs.

 

Date    Plaintiff    Verdict    Post-Trial Developments

January 2012

   Hallgren    A Highland County jury returned a verdict in favor of plaintiff and against PM USA and R.J. Reynolds. The jury awarded approximately $2 million in compensatory damages and allocated 25% of the fault to PM USA (an amount of approximately $500,000). The jury also awarded $750,000 in punitive damages against each of the defendants.    In February 2012, the defendants filed various post-trial motions, including motions for judgment notwithstanding the verdict and for a new trial. The trial court entered final judgment on March 9, 2012. Both plaintiff and defendants have filed motions to amend the judgment.

July 2011

   Weingart    A Palm Beach County jury returned a verdict in the amount of zero damages and allocated 3% of the fault to each of the defendants (PM USA, R.J. Reynolds and Lorillard Tobacco Company).    In September 2011, the trial court granted plaintiff’s motion for additur or a new trial, concluding that an additur of $150,000 is required for plaintiff’s pain and suffering. The trial court entered final judgment and, since PM USA was allocated 3% of the fault, its portion of the damages would be $4,500. PM USA has filed its notice of appeal and has posted bonds in an aggregate amount of $48,000.

April 2011

   Allen    A Duval County jury returned a verdict in favor of plaintiffs and against PM USA and R.J. Reynolds. The jury awarded a total of $6 million in compensatory damages and allocated 15% of the fault to PM USA (an amount of $900,000). The jury also awarded $17 million in punitive damages against each of the defendants.    In May 2011, the defendants filed various post-trial motions, and the trial court entered final judgment. In October 2011, the trial court granted the defendants’ motion for remittitur, reducing the punitive damages award against PM USA to $2.7 million, and denied defendants’ remaining post-trial motions. PM USA filed a notice of appeal, and posted a bond in the amount of $1.25 million in November 2011.

April 2011

   Tullo    A Palm Beach County jury returned a verdict in favor of plaintiff and against PM USA, Lorillard Tobacco Company and Liggett Group. The jury awarded a total of $4.5 million in compensatory damages and allocated 45% of the fault to PM USA (an amount of $2,025,000).    In April 2011, the trial court entered final judgment. In July 2011, PM USA filed its notice of appeal and posted a $2 million bond.

February 2011

   Huish    An Alachua County jury returned a verdict in favor of plaintiff and against PM USA. The jury awarded $750,000 in compensatory damages and allocated 25% of the fault to PM USA (an amount of $187,500). The jury also awarded $1.5 million in punitive damages against    In March 2011, the trial court entered final judgment. PM USA filed post-trial motions, which were denied in April 2011. In May 2011, PM USA filed its notice of appeal and posted a $1.7 million appeal bond. Argument on the merits of

 

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Date    Plaintiff    Verdict    Post-Trial Developments
          PM USA.    the appeal was heard on March 21, 2012. On
March 23, 2012, the Florida First District
Court of Appeal affirmed per curiam the trial
court’s decision without issuing an opinion.
On April 6, 2012, PM USA filed a motion to
extend the rehearing deadline and to stay the
issuance of the mandate.
February
2011
   Hatziyannakis    A Broward County jury returned a verdict in favor of plaintiff and against PM USA. The jury awarded approximately $270,000 in compensatory damages and allocated 32% of the fault to PM USA (an amount of approximately $86,000).    In April 2011, the trial court denied PM USA’s post-trial motions for a new trial and to set aside the verdict. In June 2011, PM USA filed its notice of appeal and posted an $86,000 appeal bond.
August
2010
   Piendle    A Palm Beach County jury returned a verdict in favor of plaintiff and against PM USA and R.J. Reynolds. The jury awarded $4 million in compensatory damages and allocated 27.5% of the fault to PM USA (an amount of approximately $1.1 million). The jury also awarded $90,000 in punitive damages against PM USA.    In September 2010, the trial court entered final judgment. In January 2011, the trial court denied the parties’ post-trial motions. PM USA filed its notice of appeal and posted a $1.2 million appeal bond.

July 2010

   Kayton (formerly Tate)    A Broward County jury returned a verdict in favor of the plaintiff and against PM USA. The jury awarded $8 million in compensatory damages and allocated 64% of the fault to PM USA (an amount of approximately $5.1 million). The jury also awarded approximately $16.2 million in punitive damages against PM USA.    In August 2010, the trial court entered final judgment, and PM USA filed its notice of appeal and posted a $5 million appeal bond.

April 2010

   Putney    A Broward County jury returned a verdict in favor of the plaintiff and against PM USA, R.J. Reynolds and Liggett Group. The jury awarded approximately $15.1 million in compensatory damages and allocated 15% of the fault to PM USA (an amount of approximately $2.3 million). The jury also awarded $2.5 million in punitive damages against PM USA.    In August 2010, the trial court entered final judgment. PM USA filed its notice of appeal and posted a $1.6 million appeal bond.

March 2010

   R. Cohen    A Broward County jury returned a verdict in favor of the plaintiff and against PM USA and R.J. Reynolds. The jury awarded $10 million in compensatory damages and allocated    In July 2010, the trial court entered final judgment and, in August 2010, PM USA filed its notice of appeal. In October 2010, PM USA posted a $2.5 million appeal bond. Argument

 

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Date    Plaintiff    Verdict    Post-Trial Developments
      33 1/3% of the fault to PM USA (an amount of approximately $3.3 million). The jury also awarded a total of $20 million in punitive damages, assessing separate $10 million awards against each defendant.    on the merits of the appeal is set for May 9, 2012. On April 13, 2012, PM USA filed a motion with the Florida Fourth District Court of Appeal to stay the appeal pending the decision of the Florida Supreme Court on whether to review the Douglas case, which motion was denied on April 19, 2012.

March 2010

   Douglas    A Hillsborough County jury returned a verdict in favor of the plaintiff and against PM USA, R.J. Reynolds and Liggett Group. The jury awarded $5 million in compensatory damages. Punitive damages were dismissed prior to trial. The jury allocated 18% of the fault to PM USA, resulting in an award of $900,000.    In June 2010, PM USA filed its notice of appeal and posted a $900,000 appeal bond. In September 2010, the plaintiff filed with the trial court a challenge to the constitutionality of the Florida bond cap statute but withdrew the challenge in August 2011. On March 30, 2012, the Florida Second District Court of Appeal issued a decision affirming the judgment and upholding the use of the Engle jury findings but certified to the Florida Supreme Court the question of whether granting res judicata effect to the Engle jury findings violates defendants’ federal due process rights. On April 2, 2012, the defendants filed a notice to invoke discretionary jurisdiction with the Florida Supreme Court.

November 2009

   Naugle    A Broward County jury returned a verdict in favor of the plaintiff and against PM USA. The jury awarded approximately $56.6 million in compensatory damages and $244 million in punitive damages. The jury allocated 90% of the fault to PM USA.    In March 2010, the trial court entered final judgment reflecting a reduced award of approximately $13 million in compensatory damages and $26 million in punitive damages. In April 2010, PM USA filed its notice of appeal and posted a $5 million appeal bond. In August 2010, upon the motion of PM USA, the trial court entered an amended final judgment of approximately $12.3 million in compensatory damages and approximately $24.5 million in punitive damages to correct a clerical error. The case remains on appeal before the Florida Fourth District Court of Appeal. Argument on the merits of the appeal was heard on February 21, 2012. On April 3, 2012, PM USA filed a motion to stay the appeal pending the decision of the Florida Supreme Court on whether to review the Douglas case, which motion was denied on April 24, 2012.

August 2009

   F. Campbell    An Escambia County jury returned a verdict in favor of the plaintiff and against R.J. Reynolds, PM USA and Liggett Group. The jury awarded $7.8 million in compensatory damages. In September 2009, the trial court entered final judgment and awarded the plaintiff    In January 2010, defendants filed their notice of appeal, and PM USA posted a $156,000 appeal bond. In March 2011, the Florida First District Court of Appeal affirmed per curiam (with citation) the trial court’s decision without issuing an

 

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Date    Plaintiff    Verdict    Post-Trial Developments
      $156,000 in damages against PM USA due to the jury allocating only 2% of the fault to PM USA.    opinion. PM USA’s motion to certify the Court of Appeal’s decision to the Florida Supreme Court as a matter of public importance was denied in May 2011. In June 2011, PM USA filed a petition for discretionary review with the Florida Supreme Court. In July 2011, the Florida Supreme Court declined to hear PM USA’s petition. In December 2011, PM USA and Liggett Group filed a joint petition for a writ of certiorari with the United States Supreme Court, and R.J. Reynolds filed a separate petition for a writ of certiorari. The Supreme Court denied certiorari on March 26, 2012. As of March 31, 2012, PM USA had a provision on its condensed consolidated balance sheet of approximately $245,000 for compensatory damages, costs and interest.

August 2009

   Barbanell    A Broward County jury returned a verdict in favor of the plaintiff, awarding $5.3 million in compensatory damages. The judge had previously dismissed the punitive damages claim. In September 2009, the trial court entered final judgment and awarded the plaintiff $1.95 million in actual damages. The judgment reduced the jury’s $5.3 million award of compensatory damages due to the jury allocating 36.5% of the fault to PM USA.    A notice of appeal was filed by PM USA in September 2009, and PM USA posted a $1.95 million appeal bond. Argument on the merits of the appeal was heard in September 2011. On February 22, 2012, the Florida Fourth District Court of Appeals reversed the judgment, holding that the statute of limitations barred the plaintiff’s claims. The plaintiff has filed a motion for rehearing en banc or, in the alternative, for certification to the Florida Supreme Court.

February 2009

   Hess    A Broward County jury found in favor of plaintiffs and against PM USA. The jury awarded $3 million in compensatory damages and $5 million in punitive damages. In June 2009, the trial court entered final judgment and awarded plaintiffs $1,260,000 in actual damages and $5 million in punitive damages. The judgment reduced the jury’s $3 million award of compensatory damages due to the jury allocating 42% of the fault to PM USA.    PM USA noticed an appeal to the Fourth District Court of Appeal in July 2009. Argument was heard in March 2011. On April 3, 2012, PM USA filed a motion to stay the appeal pending the decision of the Florida Supreme Court on whether to review the Douglas case.

 

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Appeals of Engle Progeny Verdicts

Plaintiffs in various Engle progeny cases have appealed adverse rulings or verdicts, and in some cases, PM USA has cross-appealed. PM USA’s appeals of adverse verdicts are discussed in the chart above.

Since the remand of B. Brown (discussed above under the heading Federal Engle Progeny Cases), the Eleventh Circuit’s ruling on Florida state law is currently superseded by two state appellate rulings in Martin, an Engle progeny case against R.J. Reynolds in Escambia County, and J. Brown, an Engle progeny case against R.J. Reynolds in Broward County. In Martin, the Florida First District Court of Appeal rejected the B. Brown ruling as a matter of state law and upheld the use of the Engle findings to relax plaintiffs’ burden of proof. R.J. Reynolds had sought Florida Supreme Court review in that case but, in July 2011, the Florida Supreme Court declined to hear the appeal. In December 2011, petitions for certiorari were filed with the United States Supreme Court by R.J. Reynolds in Campbell, Martin, Gray and Hall and by PM USA and Liggett Group in Campbell. The Supreme Court denied the defendants’ certiorari petitions on March 26, 2012.

In J. Brown, the Florida Fourth District Court of Appeal also rejected the B. Brown ruling as a matter of state law and upheld the use of the Engle findings to relax plaintiffs’ burden of proof. However, the Fourth District expressly disagreed with the First District’s Martin decision by ruling that Engle progeny plaintiffs must prove legal causation on their claims. In addition, the J. Brown court expressed concerns that using the Engle findings to reduce plaintiffs’ burden may violate defendants’ due process rights. In October 2011, the Fourth District denied R.J. Reynolds’ motion to certify J. Brown to the Florida Supreme Court for review. R.J. Reynolds is seeking review of the case by the Florida Supreme Court.

In Douglas, on March 30, 2012, the Florida Second District Court of Appeal issued a decision affirming the judgment of the trial court in favor of the plaintiff and upholding the use of the Engle jury findings but certified to the Florida Supreme Court the question of whether granting res judicata effect to the Engle jury findings violates defendants’ federal due process rights. On April 2, 2012, the defendants in Douglas filed a notice to invoke discretionary jurisdiction with the Florida Supreme Court.

As noted above in Federal Engle Progeny Cases, there has been no federal appellate review of the federal due process issues raised by the use of findings from the original Engle trial in Engle progeny cases.

Because of the substantial period of time required for the federal and state appellate processes, it is possible that PM USA may have to pay certain outstanding judgments in the Engle progeny cases before the final adjudication of these issues by the Florida Supreme Court or the United States Supreme Court.

Other Smoking and Health Class Actions

Since the dismissal in May 1996 of a purported nationwide class action brought on behalf of allegedly addicted smokers, plaintiffs have filed numerous putative smoking and health class action suits in various state and federal courts. In general, these cases purport to be brought on behalf of residents of a particular state or states (although a few cases purport to be nationwide in scope) and raise addiction claims and, in many cases, claims of physical injury as well.

Class certification has been denied or reversed by courts in 59 smoking and health class actions involving PM USA in Arkansas (1), California (1), the District of Columbia (2), Florida (2), Illinois (3), Iowa (1), Kansas (1), Louisiana (1), Maryland (1), Michigan (1), Minnesota (1), Nevada (29), New Jersey (6), New York (2), Ohio (1), Oklahoma (1), Pennsylvania (1), Puerto Rico (1), South Carolina (1), Texas (1) and Wisconsin (1).

PM USA and Altria Group, Inc. are named as defendants, along with other cigarette manufacturers, in six actions filed in the Canadian provinces of Alberta, Manitoba, Nova Scotia, Saskatchewan and British Columbia. In Saskatchewan and British Columbia, plaintiffs seek class certification on behalf of individuals who suffer or have suffered from various diseases including chronic obstructive pulmonary disease, emphysema, heart disease or cancer after smoking defendants’ cigarettes. In the actions filed in Alberta, Manitoba and Nova Scotia, plaintiffs seek certification of classes of all individuals who smoked defendants’ cigarettes. See Guarantees for a discussion of the Distribution Agreement between Altria Group, Inc. and PMI that provides for indemnities for certain liabilities concerning tobacco products.

 

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Scott Class Action

In July 2003, following the first phase of the trial in the Scott class action, in which plaintiffs sought creation of a fund to pay for medical monitoring and smoking cessation programs, a Louisiana jury returned a verdict in favor of defendants, including PM USA, in connection with plaintiffs’ medical monitoring claims, but also found that plaintiffs could benefit from smoking cessation assistance. The jury also found that cigarettes as designed are not defective but that the defendants failed to disclose all they knew about smoking and diseases and marketed their products to minors. In May 2004, in the second phase of the trial, the jury awarded plaintiffs approximately $590 million against all defendants jointly and severally, to fund a 10-year smoking cessation program. Defendants appealed.

In April 2010, the Louisiana Fourth Circuit Court of Appeal issued a decision that affirmed in part prior decisions ordering the defendants to fund a statewide 10-year smoking cessation program. After conducting its own independent review of the record, the Court of Appeal made its own factual findings with respect to liability and the amount owed, lowering the amount of the judgment to approximately $241 million, plus interest commencing July 21, 2008, the date of entry of the amended judgment. In addition, the Court of Appeal declined plaintiffs’ cross appeal requests for a medical monitoring program and reinstatement of other components of the smoking cessation program. The Court of Appeal specifically reserved to the defendants the right to assert claims to any unspent or unused surplus funds at the termination of the smoking cessation program. In June 2010, defendants and plaintiffs filed separate writ of certiorari applications with the Louisiana Supreme Court. The Louisiana Supreme Court denied both sides’ applications. In September 2010, upon defendants’ application, the United States Supreme Court granted a stay of the judgment pending the defendants’ filing and the Court’s disposition of the defendants’ petition for a writ of certiorari. In June 2011, the United States Supreme Court denied the defendants’ petition. In the second quarter of 2011, PM USA recorded a provision on its condensed consolidated balance sheet of approximately $36 million related to the judgment and approximately $5 million related to interest, which was in addition to a previously recorded provision of approximately $30 million.

In August 2011, PM USA paid its share of the judgment and interest in an amount of approximately $70 million. The defendants’ payments have been deposited into a court-supervised fund that is intended to pay for smoking cessation programs. In October 2011, plaintiffs’ counsel filed a motion for an award of attorneys’ fees and costs. Plaintiffs’ counsel seek additional fees from defendants ranging from approximately $96 million to $673 million. Additionally, plaintiffs’ counsel request an award of approximately $13 million in costs. As of March 31, 2012, PM USA had a provision on its condensed consolidated balance sheet of approximately $1.3 million for costs, but is opposing plaintiffs’ counsel’s request for additional costs and for fees. On March 6, 2012, the trial court denied defendants’ motion challenging plaintiffs’ counsel request that defendants pay their attorneys’ fees directly, as opposed to out of the court-supervised fund. Defendants have applied for a supervisory writ challenging the decision to the Louisiana Fourth Circuit Court of Appeal. In the meantime, a hearing is scheduled in the trial court for June 18, 2012 regarding the amount of fees that plaintiffs’ counsel are entitled to collect, regardless of the source of funds.

Other Medical Monitoring Class Actions

In addition to the Scott class action discussed above, two purported medical monitoring class actions are pending against PM USA. These two cases were brought in New York (Caronia, filed in January 2006 in the United States District Court for the Eastern District of New York) and Massachusetts (Donovan, filed in December 2006 in the United States District Court for the District of Massachusetts) on behalf of each state’s respective residents who: are age 50 or older; have smoked the Marlboro brand for 20 pack-years or more; and have neither been diagnosed with lung cancer nor are under investigation by a physician for suspected lung cancer. Plaintiffs in these cases seek to impose liability under various product-based causes of action and the creation of a court-supervised program providing members of the purported class Low Dose CT Scanning in order to identify and diagnose lung cancer. Plaintiffs in these cases do not seek punitive damages. A case brought in California (Xavier) was dismissed in July 2011, and a case brought in Florida (Gargano) was voluntarily dismissed with prejudice in August 2011.

In Caronia, in February 2010, the district court granted in part PM USA’s summary judgment motion, dismissing plaintiffs’ strict liability and negligence claims and certain other claims, granted plaintiffs leave to amend their complaint to allege a medical monitoring cause of action and requested further briefing on PM USA’s summary judgment motion as to plaintiffs’ implied warranty claim and, if plaintiffs amend their complaint, their medical monitoring claim. In March 2010, plaintiffs filed their amended complaint and PM USA moved to dismiss the implied warranty and medical monitoring claims. In January 2011, the district court granted PM USA’s motion, dismissed plaintiffs’ claims and declared plaintiffs’ motion for class certification moot in light of the dismissal of the case. The

 

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plaintiffs have appealed that decision to the United States Court of Appeals for the Second Circuit. Argument before the Second Circuit was heard on March 1, 2012.

In Donovan, the Supreme Judicial Court of Massachusetts, in answering questions certified to it by the district court, held in October 2009 that under certain circumstances state law recognizes a claim by individual smokers for medical monitoring despite the absence of an actual injury. The court also ruled that whether or not the case is barred by the applicable statute of limitations is a factual issue to be determined by the trial court. The case was remanded to federal court for further proceedings. In June 2010, the district court granted in part the plaintiffs’ motion for class certification, certifying the class as to plaintiffs’ claims for breach of implied warranty and violation of the Massachusetts Consumer Protection Act, but denying certification as to plaintiffs’ negligence claim. In July 2010, PM USA petitioned the United States Court of Appeals for the First Circuit for appellate review of the class certification decision. The petition was denied in September 2010. As a remedy, plaintiffs have proposed a 28-year medical monitoring program with an approximate cost of $190 million. In April 2011, plaintiffs moved to amend their class certification to extend the cut-off date for individuals to satisfy the class membership criteria from December 14, 2006 to August 1, 2011. The district court granted this motion in May 2011. In June 2011, plaintiffs filed various motions for summary judgment and to strike affirmative defenses. In October 2011, PM USA filed a motion for class decertification, which motion was denied on March 21, 2012. A trial date has not been set.

Evolving medical standards and practices could have an impact on the defense of medical monitoring claims. For example, the first publication of the findings of the National Cancer Institute’s National Lung Screening Trial (NLST) in June 2011 reported a 20% reduction in lung cancer deaths among certain long term smokers receiving Low Dose CT Scanning for lung cancer. Since then, various public health organizations have begun to develop new lung cancer screening guidelines. Also, a number of hospitals have advertised the availability of screening programs. Other studies in this area are ongoing.

Health Care Cost Recovery Litigation

Overview

In the health care cost recovery litigation, governmental entities and non-governmental plaintiffs seek reimbursement of health care cost expenditures allegedly caused by tobacco products and, in some cases, of future expenditures and damages as well. Relief sought by some but not all plaintiffs includes punitive damages, multiple damages and other statutory damages and penalties, injunctions prohibiting alleged marketing and sales to minors, disclosure of research, disgorgement of profits, funding of anti-smoking programs, additional disclosure of nicotine yields, and payment of attorney and expert witness fees.

The claims asserted include the claim that cigarette manufacturers were “unjustly enriched” by plaintiffs’ payment of health care costs allegedly attributable to smoking, as well as claims of indemnity, negligence, strict liability, breach of express and implied warranty, violation of a voluntary undertaking or special duty, fraud, negligent misrepresentation, conspiracy, public nuisance, claims under federal and state statutes governing consumer fraud, antitrust, deceptive trade practices and false advertising, and claims under federal and state anti-racketeering statutes.

Defenses raised include lack of proximate cause, remoteness of injury, failure to state a valid claim, lack of benefit, adequate remedy at law, “unclean hands” (namely, that plaintiffs cannot obtain equitable relief because they participated in, and benefited from, the sale of cigarettes), lack of antitrust standing and injury, federal preemption, lack of statutory authority to bring suit, and statutes of limitations. In addition, defendants argue that they should be entitled to “set off” any alleged damages to the extent the plaintiffs benefit economically from the sale of cigarettes through the receipt of excise taxes or otherwise. Defendants also argue that these cases are improper because plaintiffs must proceed under principles of subrogation and assignment. Under traditional theories of recovery, a payor of medical costs (such as an insurer) can seek recovery of health care costs from a third party solely by “standing in the shoes” of the injured party. Defendants argue that plaintiffs should be required to bring any actions as subrogees of individual health care recipients and should be subject to all defenses available against the injured party.

Although there have been some decisions to the contrary, most judicial decisions in the United States have dismissed all or most health care cost recovery claims against cigarette manufacturers. Nine federal circuit courts of appeals and eight state appellate courts, relying primarily on grounds that plaintiffs’ claims were too remote, have ordered or affirmed dismissals of health care cost recovery actions. The United States Supreme Court has refused to consider

 

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plaintiffs’ appeals from the cases decided by five circuit courts of appeals. In 2011, in the health care cost recovery case brought against PM USA and other defendants by the City of St. Louis, Missouri and approximately 40 Missouri hospitals, a verdict was returned in favor of the defendants.

Individuals and associations have also sued in purported class actions or as private attorneys general under the Medicare as Secondary Payer (“MSP”) provisions of the Social Security Act to recover from defendants Medicare expenditures allegedly incurred for the treatment of smoking-related diseases. Cases were brought in New York (2), Florida (2) and Massachusetts (1). All were dismissed by federal courts.

In addition to the cases brought in the United States, health care cost recovery actions have also been brought against tobacco industry participants, including PM USA and Altria Group, Inc., in Israel (dismissed), the Marshall Islands (dismissed), and Canada (4), and other entities have stated that they are considering filing such actions. In the case in Israel (Clalit), in July 2011, the Israel Supreme Court reversed the trial court’s decision denying defendants’ motion to dismiss and dismissed the case. In August 2011, plaintiff filed a motion for rehearing with the Israel Supreme Court, which the court denied in January 2012. This litigation has concluded.

In September 2005, in the first of the four health care cost recovery cases filed in Canada, the Canadian Supreme Court ruled that legislation passed in British Columbia permitting the lawsuit is constitutional, and, as a result, the case, which had previously been dismissed by the trial court, was permitted to proceed. PM USA’s and other defendants’ challenge to the British Columbia court’s exercise of jurisdiction was rejected by the Court of Appeals of British Columbia and, in April 2007, the Supreme Court of Canada denied review of that decision. In December 2009, the Court of Appeals of British Columbia ruled that certain defendants can proceed against the Federal Government of Canada as third parties on the theory that the Federal Government of Canada negligently misrepresented to defendants the efficacy of a low tar tobacco variety that the Federal Government of Canada developed and licensed to defendants. In May 2010, the Supreme Court of Canada granted leave to the Federal Government of Canada to appeal this decision and leave to defendants to cross-appeal the Court of Appeals’ decision to dismiss claims against the Federal Government of Canada based on other theories of liability. In July 2011, the Supreme Court of Canada dismissed the third-party claims against the Federal Government of Canada.

During 2008, the Province of New Brunswick, Canada, proclaimed into law previously adopted legislation allowing reimbursement claims to be brought against cigarette manufacturers, and it filed suit shortly thereafter. In September 2009, the Province of Ontario, Canada, filed suit against a number of cigarette manufacturers based on previously adopted legislation nearly identical in substance to the New Brunswick health care cost recovery legislation. In February 2011, the Province of Newfoundland and Labrador filed a case substantially similar to the ones brought by New Brunswick and Ontario.

PM USA is named as a defendant in the British Columbia case, while Altria Group, Inc. and PM USA are named as defendants in the New Brunswick, Ontario and Newfoundland cases. Several other provinces and territories in Canada have enacted similar legislation or are in the process of enacting similar legislation. See Guarantees for a discussion of the Distribution Agreement between Altria Group, Inc. and PMI that provides for indemnities for certain liabilities concerning tobacco products.

Settlements of Health Care Cost Recovery Litigation

In November 1998, PM USA and certain other United States tobacco product manufacturers entered into the MSA with 46 states, the District of Columbia, Puerto Rico, Guam, the United States Virgin Islands, American Samoa and the Northern Marianas to settle asserted and unasserted health care cost recovery and other claims. PM USA and certain other United States tobacco product manufacturers had previously settled similar claims brought by Mississippi, Florida, Texas and Minnesota (together with the MSA, the “State Settlement Agreements”). The State Settlement Agreements require that the original participating manufacturers make substantial annual payments of approximately $9.4 billion each year, subject to adjustments for several factors, including inflation, market share and industry volume. In addition, the original participating manufacturers are required to pay settling plaintiffs’ attorneys’ fees, subject to an annual cap of $500 million. For the three months ended March 31, 2012 and March 31, 2011, the aggregate amount recorded in cost of sales with respect to the State Settlement Agreements and the Fair and Equitable Tobacco Reform Act of 2004 (“FETRA”) was approximately $1.1 billion for each period.

 

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The State Settlement Agreements also include provisions relating to advertising and marketing restrictions, public disclosure of certain industry documents, limitations on challenges to certain tobacco control and underage use laws, restrictions on lobbying activities and other provisions.

Possible Adjustments in MSA Payments for 2003 to 2011

Pursuant to the provisions of the MSA, domestic tobacco product manufacturers, including PM USA, who are original signatories to the MSA (the “Original Participating Manufacturers” or “OPMs”) are participating in proceedings that may result in downward adjustments to the amounts paid by the OPMs and the other MSA-participating manufacturers to the states and territories that are parties to the MSA for each of the years 2003 to 2011. The proceedings relate to an MSA payment adjustment (the “NPM Adjustment”) based on the collective loss of market share for the relevant year by all participating manufacturers who are subject to the payment obligations and marketing restrictions of the MSA to non-participating manufacturers (“NPMs”) who are not subject to such obligations and restrictions.

As part of these proceedings, an independent economic consulting firm jointly selected by the MSA parties or otherwise selected pursuant to the MSA’s provisions is required to determine whether the disadvantages of the MSA were a “significant factor” contributing to the participating manufacturers’ collective loss of market share for the year in question. If the firm determines that the disadvantages of the MSA were such a “significant factor,” each state may avoid a downward adjustment to its share of the participating manufacturers’ annual payments for that year by establishing that it diligently enforced a qualifying escrow statute during the entirety of that year. Any potential downward adjustment would then be reallocated to any states that do not establish such diligent enforcement. PM USA believes that the MSA’s arbitration clause requires a state to submit its claim to have diligently enforced a qualifying escrow statute to binding arbitration before a panel of three former federal judges in the manner provided for in the MSA. A number of states have taken the position that this claim should be decided in state court on a state-by-state basis.

An independent economic consulting firm, jointly selected by the MSA parties, determined that the disadvantages of the MSA were a significant factor contributing to the participating manufacturers’ collective loss of market share for each of the years 2003-2005. A different independent economic consulting firm, jointly selected by the MSA parties, determined that the disadvantages of the MSA were a significant factor contributing to the participating manufacturers’ collective loss of market share for the year 2006. Following the firm’s determination for 2006, the OPMs and the states agreed that the states would not contest that the disadvantages of the MSA were a significant factor contributing to the participating manufacturers’ collective loss of market share for the years 2007, 2008 and 2009. Accordingly, the OPMs and the states have agreed that no “significant factor” determination by an independent economic consulting firm will be necessary with respect to the participating manufacturers’ collective loss of market share for the years 2007, 2008 and 2009 (the “significant factor agreement”). This agreement became effective for 2007, 2008 and 2009 on February 1, 2010, 2011 and 2012, respectively. The OPMs and the states have agreed to extend the significant factor agreement to apply to the participating manufacturers’ collective loss of market share for 2010 and 2011, as well as to any collective loss of market share that the participating manufacturers experience for 2012. This agreement will become effective for 2010 on February 1, 2013 and for 2011 on February 1, 2014. If the MSA’s Independent Auditor determines that the participating manufacturers collectively lost market share for 2012, this agreement will become effective for 2012 on February 1, 2015.

Following the “significant factor” determination with respect to 2003, thirty-eight states filed declaratory judgment actions in state courts seeking a declaration that the state diligently enforced its escrow statute during 2003. The OPMs and other MSA-participating manufacturers responded to these actions by filing motions to compel arbitration in accordance with the terms of the MSA, including filing motions to compel arbitration in eleven MSA states and territories that did not file declaratory judgment actions. Courts in all but one of the forty-six MSA states and the District of Columbia and Puerto Rico have ruled that the question of whether a state diligently enforced its escrow statute during 2003 is subject to arbitration. Several of these rulings may be subject to further review. One state court (in State of Montana) has ruled that the diligent enforcement claims of that state may be litigated in state court, rather than in arbitration. In January 2010, the OPMs filed a petition for a writ of certiorari in the United States Supreme Court seeking further review of the Montana decision holding that a state’s diligent enforcement claims may be litigated in state court, rather than in arbitration. The petition was denied in June 2010. Following the denial of this petition, Montana renewed an action in its state court seeking a declaratory judgment that it diligently enforced its escrow statute during 2003 and other relief. The case is now proceeding in the trial court.

 

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PM USA, the other OPMs and approximately twenty-five other MSA-participating manufacturers have entered into an agreement regarding arbitration with forty-five MSA states concerning the 2003 NPM Adjustment, including the states’ claims of diligent enforcement for 2003. The agreement further provides for a partial liability reduction for the 2003 NPM Adjustment for states that entered into the agreement by January 30, 2009 and are determined in the arbitration not to have diligently enforced a qualifying escrow statute during 2003. Based on the number of states that entered into the agreement by January 30, 2009 (forty-five), the partial liability reduction for those states is 20%. The partial liability reduction would reduce the amount of PM USA’s 2003 NPM Adjustment by up to a corresponding percentage. The selection of the arbitration panel for the 2003 NPM Adjustment was completed in July 2010, and the arbitration is currently ongoing. Proceedings to determine state diligent enforcement claims for the years 2004 through 2011 have not yet been scheduled.

Once a significant factor determination in favor of the participating manufacturers for a particular year has been made by an economic consulting firm, or the states’ agreement not to contest significant factor for a particular year has become effective, PM USA has the right under the MSA to pay the disputed amount of the NPM Adjustment for that year into a disputed payments account or withhold it altogether. PM USA has made its full MSA payment due in each year from 2006 – 2010 to the states (subject to a right to recoup the NPM Adjustment amount in the form of a credit against future MSA payments), even though it had the right to deduct the disputed amounts of the 2003 – 2007 NPM Adjustments, as described above, from such MSA payments. PM USA paid its share of the amount of the disputed 2008 and 2009 NPM Adjustments shown below into the MSA’s disputed payments account in connection with its MSA payments due in 2011 and 2012, respectively. The approximate maximum principal amounts of PM USA’s share of the disputed NPM Adjustment for the years 2003 through 2011, as currently calculated by the MSA’s Independent Auditor, are as follows (the amounts shown below do not include the interest or earnings thereon to which PM USA believes it would be entitled in the manner provided in the MSA and do not reflect the partial liability reduction for the 2003 NPM Adjustment pursuant to the arbitration agreement described above):

 

Year for which NPM Adjustment calculated

     2003        2004         2005        2006        2007        2008        2009        2010         2011   

Year in which deduction for NPM Adjustment may be taken

     2006         2007         2008         2009         2010         2011         2012         2013         2014   

PM USA’s Approximate Share of Disputed NPM Adjustment (in millions)

   $ 337       $ 388       $ 181       $ 154       $ 185       $ 252       $ 206       $ 208       $ 137   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The foregoing amounts may be recalculated by the MSA’s Independent Auditor if it receives information that is different from or in addition to the information on which it based these calculations, including, among other things, if it receives revised sales volumes from any participating manufacturer. Disputes among the manufacturers could also reduce the foregoing amounts. The availability and the precise amount of any NPM Adjustment for 2003 – 2011 will not be finally determined until 2013 or thereafter. There is no certainty that the OPMs and other MSA-participating manufacturers will ultimately receive any adjustment as a result of these proceedings, and the amount of any adjustment received for a year could be less than the amount for that year listed above. If the OPMs do receive such an adjustment through these proceedings, the adjustment would be allocated among the OPMs pursuant to the MSA’s

 

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provisions. It is expected that PM USA would receive its share of any adjustments for 2003 – 2007 in the form of a credit against future MSA payments and its share of any adjustment for 2008 or 2009 in the form of a withdrawal from the disputed payments account.

PM USA intends to pursue vigorously the disputed NPM Adjustments for 2003 – 2011 through the proceedings described above. PM USA would be willing, however, to enter into a settlement of those disputed NPM Adjustments if it determined that such a settlement were in its best interests.

Other Disputes Related to MSA Payments

In addition to the disputed NPM Adjustments described above, MSA states and participating manufacturers, including PM USA, are conducting another arbitration to resolve certain other disputes related to the calculation of the participating manufacturers’ payments under the MSA. PM USA disputes the method by which ounces of “roll your own” tobacco have been converted to cigarettes for purposes of calculating the downward volume adjustments to its MSA payments. PM USA believes that, for the years 2004-2012, the use of an incorrect conversion method resulted in excess MSA payments by PM USA in those years of approximately $92 million in the aggregate. If PM USA prevails on this issue, it would be entitled to a credit against future MSA payments in that amount, plus interest. In addition, PM USA seeks application of what it believes to be the correct method for payments to be made in years subsequent to 2012.

This arbitration will also resolve a dispute concerning whether the total domestic cigarette market and certain other calculations related to the participating manufacturers’ MSA payments should be determined based on the “net” number of cigarettes on which federal excise tax is paid, as is currently the case, or whether the “adjusted gross” number of cigarettes on which federal excise tax is paid is the correct methodology. PM USA does not have sufficient information at this time to determine the aggregate impact on its MSA payments that would result from a change from the “net” to the “adjusted gross” methodology.

PM USA anticipates that this arbitration will not be concluded until later in 2012 or thereafter. No assurance can be given that PM USA will prevail in this arbitration.

Other MSA-Related Litigation

PM USA was named as a defendant in an action (Vibo) brought in October 2008 in federal court in Kentucky by an MSA participating manufacturer that is not an OPM. Other defendants include various other participating manufacturers and the Attorneys General of all 52 states and territories that are parties to the MSA. The plaintiff alleged that certain of the MSA’s payment provisions discriminate against it in favor of certain other participating manufacturers in violation of the federal antitrust laws and the United States Constitution. The plaintiff also sought injunctive relief, alteration of certain MSA payment provisions as applied to it, treble damages under the federal antitrust laws, and/or rescission of its joinder in the MSA. The plaintiff also filed a motion for a preliminary injunction enjoining the states from enforcing the allegedly discriminatory payment provisions against it during the pendency of the action. In January 2009, the district court dismissed the complaint and denied plaintiff’s request for preliminary injunctive relief. In January 2010, the court entered final judgment dismissing the case. Plaintiff appealed this decision to the United States Court of Appeals for the Sixth Circuit. On February 22, 2012, the Sixth Circuit affirmed the district court’s dismissal of the case.

Without naming PM USA or any other private party as a defendant, NPMs and/or their distributors or customers have filed several legal challenges to the MSA and related legislation. New York state officials and the Attorneys General for 24 other states are defendants in a lawsuit (King, formerly Pryor) filed in the United States District Court for the Southern District of New York in which plaintiffs allege that the MSA and/or related legislation violates federal antitrust laws and the Commerce Clause of the United States Constitution. The United States Court of Appeals for the Second Circuit has held that the allegations in that lawsuit, if proven, establish a basis for relief on antitrust and Commerce Clause grounds and that the trial courts in New York have personal jurisdiction sufficient to enjoin other states’ officials from enforcing their MSA-related legislation. On remand, the trial court held that plaintiffs are unlikely to succeed on the merits and refused to enjoin the enforcement of New York’s allocable share amendment to the MSA’s Model Escrow Statute. That decision was affirmed by the United States Court of Appeals for the Second Circuit. In March 2011, the trial court granted summary judgment on all claims for the New York state officials. Plaintiffs filed a motion to modify the judgment, which the trial court denied in January 2012. The matter is now on

 

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appeal before the Second Circuit. In October, November and December 2011, plaintiffs voluntarily dismissed six states from the case.

In addition to the King decision above, the United States Courts of Appeals for the Second, Fifth, Sixth, Eighth, Ninth and Tenth Circuits have affirmed dismissals or grants of summary judgment in favor of state officials in seven other cases asserting antitrust and constitutional challenges to the allocable share amendment legislation in those states.

In January 2011, an international arbitration tribunal rejected claims brought against the United States challenging MSA-related legislation in various states under the North American Free Trade Agreement.

Federal Government’s Lawsuit

In 1999, the United States government filed a lawsuit in the United States District Court for the District of Columbia against various cigarette manufacturers, including PM USA, and others, including Altria Group, Inc. asserting claims under three federal statutes, namely the Medical Care Recovery Act (“MCRA”), the MSP provisions of the Social Security Act and the civil provisions of RICO. Trial of the case ended in June 2005. The lawsuit sought to recover an unspecified amount of health care costs for tobacco-related illnesses allegedly caused by defendants’ fraudulent and tortious conduct and paid for by the government under various federal health care programs, including Medicare, military and veterans’ health benefits programs, and the Federal Employees Health Benefits Program. The complaint alleged that such costs total more than $20 billion annually. It also sought what it alleged to be equitable and declaratory relief, including disgorgement of profits which arose from defendants’ allegedly tortious conduct, an injunction prohibiting certain actions by the defendants, and a declaration that the defendants are liable for the federal government’s future costs of providing health care resulting from defendants’ alleged past tortious and wrongful conduct. In September 2000, the trial court dismissed the government’s MCRA and MSP claims, but permitted discovery to proceed on the government’s claims for relief under the civil provisions of RICO.

The government alleged that disgorgement by defendants of approximately $280 billion is an appropriate remedy. In May 2004, the trial court issued an order denying defendants’ motion for partial summary judgment limiting the disgorgement remedy. In February 2005, a panel of the United States Court of Appeals for the District of Columbia Circuit held that disgorgement is not a remedy available to the government under the civil provisions of RICO and entered summary judgment in favor of defendants with respect to the disgorgement claim. In July 2005, the government petitioned the United States Supreme Court for further review of the Court of Appeals’ ruling that disgorgement is not an available remedy, and in October 2005, the Supreme Court denied the petition.

In June 2005, the government filed with the trial court its proposed final judgment seeking remedies of approximately $14 billion, including $10 billion over a five-year period to fund a national smoking cessation program and $4 billion over a ten-year period to fund a public education and counter-marketing campaign. Further, the government’s proposed remedy would have required defendants to pay additional monies to these programs if targeted reductions in the smoking rate of those under 21 are not achieved according to a prescribed timetable. The government’s proposed remedies also included a series of measures and restrictions applicable to cigarette business operations-including, but not limited to, restrictions on advertising and marketing, potential measures with respect to certain price promotional activities and research and development, disclosure requirements for certain confidential data and implementation of a monitoring system with potential broad powers over cigarette operations.

In August 2006, the federal trial court entered judgment in favor of the government. The court held that certain defendants, including Altria Group, Inc. and PM USA, violated RICO and engaged in 7 of the 8 “sub-schemes” to defraud that the government had alleged. Specifically, the court found that:

 

   

defendants falsely denied, distorted and minimized the significant adverse health consequences of smoking;

 

   

defendants hid from the public that cigarette smoking and nicotine are addictive;

 

   

defendants falsely denied that they control the level of nicotine delivered to create and sustain addiction;

 

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defendants falsely marketed and promoted “low tar/light” cigarettes as less harmful than full-flavor cigarettes;

 

   

defendants falsely denied that they intentionally marketed to youth;

 

   

defendants publicly and falsely denied that ETS is hazardous to non-smokers; and

 

   

defendants suppressed scientific research.

The court did not impose monetary penalties on the defendants, but ordered the following relief: (i) an injunction against “committing any act of racketeering” relating to the manufacturing, marketing, promotion, health consequences or sale of cigarettes in the United States; (ii) an injunction against participating directly or indirectly in the management or control of the Council for Tobacco Research, the Tobacco Institute, or the Center for Indoor Air Research, or any successor or affiliated entities of each; (iii) an injunction against “making, or causing to be made in any way, any material false, misleading, or deceptive statement or representation or engaging in any public relations or marketing endeavor that is disseminated to the United States public and that misrepresents or suppresses information concerning cigarettes”; (iv) an injunction against conveying any express or implied health message through use of descriptors on cigarette packaging or in cigarette advertising or promotional material, including “lights,” “ultra lights” and “low tar,” which the court found could cause consumers to believe one cigarette brand is less hazardous than another brand; (v) the issuance of “corrective statements” in various media regarding the adverse health effects of smoking, the addictiveness of smoking and nicotine, the lack of any significant health benefit from smoking “low tar” or “light” cigarettes, defendants’ manipulation of cigarette design to ensure optimum nicotine delivery and the adverse health effects of exposure to environmental tobacco smoke; (vi) the disclosure on defendants’ public document websites and in the Minnesota document repository of all documents produced to the government in the lawsuit or produced in any future court or administrative action concerning smoking and health until 2021, with certain additional requirements as to documents withheld from production under a claim of privilege or confidentiality; (vii) the disclosure of disaggregated marketing data to the government in the same form and on the same schedule as defendants now follow in disclosing such data to the Federal Trade Commission (“FTC”) for a period of ten years; (viii) certain restrictions on the sale or transfer by defendants of any cigarette brands, brand names, formulas or cigarette businesses within the United States; and (ix) payment of the government’s costs in bringing the action.

The defendants appealed and, in May 2009, a three judge panel of the Court of Appeals for the District of Columbia Circuit issued a per curiam decision largely affirming the trial court’s judgment against defendants and in favor of the government. Although the panel largely affirmed the remedial order that was issued by the trial court, it vacated the following aspects of the order:

 

   

its application to defendants’ subsidiaries;

 

   

the prohibition on the use of express or implied health messages or health descriptors, but only to the extent of extraterritorial application;

 

   

its point-of-sale display provisions; and

 

   

its application to Brown & Williamson Holdings.

The Court of Appeals panel remanded the case for the trial court to reconsider these four aspects of the injunction and to reformulate its remedial order accordingly.

 

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Furthermore, the Court of Appeals panel rejected all of the government’s and intervenors’ cross appeal arguments and refused to broaden the remedial order entered by the trial court. The Court of Appeals panel also left undisturbed its prior holding that the government cannot obtain disgorgement as a permissible remedy under RICO.

In July 2009, defendants filed petitions for a rehearing before the panel and for a rehearing by the entire Court of Appeals. Defendants also filed a motion to vacate portions of the trial court’s judgment on the grounds of mootness because of the passage of the Family Smoking Prevention and Tobacco Control Act (“FSPTCA”), granting the United States Food and Drug Administration (the “FDA”) broad authority over the regulation of tobacco products. In September 2009, the Court of Appeals entered three per curiam rulings. Two of them denied defendants’ petitions for panel rehearing or for rehearing en banc. In the third per curiam decision, the Court of Appeals denied defendants’ suggestion of mootness and motion for partial vacatur. In February 2010, PM USA and Altria Group, Inc. filed their certiorari petitions with the United States Supreme Court. In addition, the federal government and the intervenors filed their own certiorari petitions, asking the court to reverse an earlier Court of Appeals decision and hold that civil RICO allows the trial court to order disgorgement as well as other equitable relief, such as smoking cessation remedies, designed to redress continuing consequences of prior RICO violations. In June 2010, the United States Supreme Court denied all of the parties’ petitions. In July 2010, the Court of Appeals issued its mandate lifting the stay of the trial court’s judgment and remanding the case to the trial court. As a result of the mandate, except for those matters remanded to the trial court for further proceedings, defendants are now subject to the injunction discussed above and the other elements of the trial court’s judgment.

In February 2011, the government submitted its proposed corrective statements and the trial court referred issues relating to a document repository to a special master. The defendants filed a response to the government’s proposed corrective statements and filed a motion to vacate the trial court’s injunction in light of the FSPTCA, which motion was denied in June 2011. The defendants have appealed the trial court’s ruling to the United States Court of Appeals for the District of Columbia Circuit. Argument was heard on April 20, 2012.

Apart from the matters on appeal, two issues remain pending before the district court: (i) the substance of the court-ordered corrective statements and (ii) the requirements related to point-of-sale signage. In November 2011, the district court ordered the parties to submit their views on whether the district court should delay its order on these issues while other courts decide more recent cases challenging the FDA’s new rules imposing certain tobacco marketing restrictions and graphic warnings. The parties complied with the district court’s requests, and defendants asked the court to defer resolution of these issues until these other cases are fully resolved. In January 2012, the district court ruled that it would not delay its decision until after the resolution of the cases challenging the FDA’s new rules. The district court has not addressed the content of the corrective communications or the requirements related to point-of-sale signage.

In December 2011, the parties to the lawsuit entered into an agreement as to the issues concerning the document repository. Pursuant to this agreement, PM USA agreed to deposit an amount of approximately $3.1 million into the district court in installments over a five-year period.

“Lights/Ultra Lights” Cases

Overview

Plaintiffs in certain pending matters seek certification of their cases as class actions and allege, among other things, that the uses of the terms “Lights” and/or “Ultra Lights” constitute deceptive and unfair trade practices, common law fraud, or RICO violations, and seek injunctive and equitable relief, including restitution and, in certain cases, punitive damages. These class actions have been brought against PM USA and, in certain instances, Altria Group, Inc. or its subsidiaries, on behalf of individuals who purchased and consumed various brands of cigarettes, including Marlboro Lights, Marlboro Ultra Lights, Virginia Slims Lights and Superslims, Merit Lights and Cambridge Lights. Defenses raised in these cases include lack of misrepresentation, lack of causation, injury and damages, the statute of limitations, non-liability under state statutory provisions exempting conduct that complies with federal regulatory directives, and the First Amendment. As of April 23, 2012, a total of eighteen such cases were pending in the United States. Four of these cases were pending in a multidistrict litigation proceeding in a single U.S. federal court as discussed below. The other cases were pending in various U.S. state courts. In addition, a purported “Lights” class action is pending against PM USA in Israel.

 

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In the one “Lights” case pending in Israel (El-Roy), hearings on plaintiffs’ motion for class certification were held in November and December 2008, and an additional hearing on class certification was held in November 2011. See Guarantees for a discussion of the Distribution Agreement between Altria Group, Inc. and PMI that provides for indemnities for certain liabilities concerning tobacco products.

The Good Case

In May 2006, a federal trial court in Maine granted PM USA’s motion for summary judgment in Good, a purported “Lights” class action, on the grounds that plaintiffs’ claims are preempted by the Federal Cigarette Labeling and Advertising Act (“FCLAA”) and dismissed the case. In August 2007, the United States Court of Appeals for the First Circuit vacated the district court’s grant of PM USA’s motion for summary judgment on federal preemption grounds and remanded the case to district court. The district court stayed the case pending the United States Supreme Court’s ruling on defendants’ petition for writ of certiorari, which was granted in January 2008. The case was stayed pending the United States Supreme Court’s decision. In December 2008, the United States Supreme Court ruled that plaintiffs’ claims are not barred by federal preemption. Although the Court rejected the argument that the FTC’s actions were so extensive with respect to the descriptors that the state law claims were barred as a matter of federal law, the Court’s decision was limited: it did not address the ultimate merits of plaintiffs’ claim, the viability of the action as a class action, or other state law issues. The case was returned to the federal court in Maine and consolidated with other federal cases in the multidistrict litigation proceeding discussed below. In June 2011, the plaintiffs voluntarily dismissed the case without prejudice after the district court denied plaintiffs’ motion for class certification.

Federal Multidistrict Proceeding

Since the December 2008 United States Supreme Court decision in Good, and through April 23, 2012, twenty-four purported “Lights” class actions were served upon PM USA and, in certain cases, Altria Group, Inc. These cases were filed in 14 states, the U.S. Virgin Islands and the District of Columbia. All of these cases either were filed in federal court or were removed to federal court by PM USA.

A number of purported “Lights” class actions were transferred and consolidated by the Judicial Panel on Multidistrict Litigation (“JPMDL”) before the United States District Court for the District of Maine for pretrial proceedings (“MDL proceeding”). These cases, and the states in which each originated, included: Biundo (Illinois), Cabbat (Hawaii), Calistro (U.S. Virgin Islands), Corse (Tennessee), Domaingue (New York), Good (Maine), Haubrich (Pennsylvania), McClure (Tennessee), Mirick (Mississippi), Mulford (New Mexico), Parsons (District of Columbia), Phillips (Ohio), Slater (District of Columbia), Tang (New York), Tyrer (California), Williams (Arkansas) and Wyatt (Wisconsin).

In November 2010, the district court in the MDL proceeding denied plaintiffs’ motion for class certification in four cases, covering the jurisdictions of California, the District of Columbia, Illinois and Maine. These jurisdictions were selected by the parties as sample cases, with two selected by plaintiffs and two selected by defendants. Plaintiffs sought appellate review of this decision but, in February 2011, the United States Court of Appeals for the First Circuit denied plaintiffs’ petition for leave to appeal. In June 2011, plaintiffs in twelve cases voluntarily dismissed without prejudice their cases, and in August 2011, plaintiff in McClure voluntarily dismissed the case without prejudice. In December 2011, the district court approved the request of the plaintiffs in the remaining four cases (Phillips, Tang, Wyatt and Cabbat) to recommend to the JPMDL that their cases be transferred back to the federal district courts in which the suits originated. On April 16, 2012, the JPMDL remanded the four cases to those originating courts.

“Lights” Cases Dismissed, Not Certified or Ordered De-Certified

To date, in addition to the district court in the MDL proceeding, 14 courts in 15 “Lights” cases have refused to certify class actions, dismissed class action allegations, reversed prior class certification decisions or have entered judgment in favor of PM USA.

Trial courts in Arizona, Illinois, Kansas, New Jersey, New Mexico, Oregon, Tennessee and Washington have refused to grant class certification or have dismissed plaintiffs’ class action allegations. Plaintiffs voluntarily dismissed a case in Michigan after a trial court dismissed the claims plaintiffs asserted under the Michigan Unfair Trade and Consumer Protection Act.

 

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Several appellate courts have issued rulings that either affirmed rulings in favor of Altria Group, Inc. and/or PM USA or reversed rulings entered in favor of plaintiffs. In Florida, an intermediate appellate court overturned an order by a trial court that granted class certification in Hines. The Florida Supreme Court denied review in January 2008. The Supreme Court of Illinois has overturned a judgment that awarded damages to a certified class in the Price case. See The Price Case below for further discussion. In Louisiana, the United States Court of Appeals for the Fifth Circuit dismissed a purported “Lights” class action brought in Louisiana federal court (Sullivan) on the grounds that plaintiffs’ claims were preempted by the FCLAA. In New York, the United States Court of Appeals for the Second Circuit overturned a decision by a New York trial court in Schwab that denied defendants’ summary judgment motions and granted plaintiffs’ motion for certification of a nationwide class of all United States residents that purchased cigarettes in the United States that were labeled “Light” or “Lights.” In July 2010, plaintiffs in Schwab voluntarily dismissed the case with prejudice. In Ohio, the Ohio Supreme Court overturned class certifications in the Marrone and Phillips cases. Plaintiffs voluntarily dismissed without prejudice both cases in August 2009. The Supreme Court of Washington denied a motion for interlocutory review filed by the plaintiffs in the Davies case that sought review of an order by the trial court that refused to certify a class. Plaintiffs subsequently voluntarily dismissed the Davies case with prejudice.

In Oregon (Pearson), a state court denied plaintiff’s motion for interlocutory review of the trial court’s refusal to certify a class. In February 2007, PM USA filed a motion for summary judgment based on federal preemption and the Oregon statutory exemption. In September 2007, the district court granted PM USA’s motion based on express preemption under the FCLAA, and plaintiffs appealed this dismissal and the class certification denial to the Oregon Court of Appeals. Argument was held in April 2010.

In Cleary, which was pending in an Illinois federal court, the district court dismissed plaintiffs’ “Lights” claims against one defendant and denied plaintiffs’ request to remand the case to state court. In September 2009, the court issued its ruling on PM USA’s and the remaining defendants’ motion for summary judgment as to all “Lights” claims. The court granted the motion as to all defendants except PM USA. As to PM USA, the court granted the motion as to all “Lights” and other low tar brands other than Marlboro Lights. As to Marlboro Lights, the court ordered briefing on why the 2002 state court order dismissing the Marlboro Lights claims should not be vacated based upon Good. In January 2010, the court vacated the previous dismissal. In February 2010, the court granted summary judgment in favor of defendants as to all claims except for the Marlboro Lights claims, based on the statute of limitations and deficiencies relating to the named plaintiffs. In June 2010, the court granted summary judgment in favor of all defendants on all remaining claims, dismissing the case. In July 2010, plaintiffs filed a motion for reconsideration with the district court, which was denied. In August 2010, plaintiffs filed an appeal with the United States Court of Appeals for the Seventh Circuit. In August 2011, the Seventh Circuit affirmed the trial court’s dismissal of the case. Plaintiffs’ petition for rehearing was denied by the Seventh Circuit in November 2011. This litigation has concluded.

Other Developments

In December 2009, the state trial court in the Carroll (formerly known as Holmes) case (pending in Delaware), denied PM USA’s motion for summary judgment based on an exemption provision in the Delaware Consumer Fraud Act. In January 2011, the trial court allowed the plaintiffs to file an amended complaint substituting class representatives and naming Altria Group, Inc. and PMI as additional defendants. In July 2011, the parties stipulated to the dismissal without prejudice of Altria Group, Inc. and PMI. The stipulation is signed by the parties but not yet approved by the trial court. See Guarantees for a discussion of the Distribution Agreement between Altria Group, Inc. and PMI that provides for indemnities for certain liabilities concerning tobacco products.

In June 2007, the United States Supreme Court reversed the lower court rulings in the Miner (formerly known as Watson) case that denied plaintiffs’ motion to have the case heard in a state, as opposed to federal, trial court. The Supreme Court rejected defendants’ contention that the case must be tried in federal court under the “federal officer” statute. The case was removed to federal court in Arkansas and the case was transferred to the MDL proceeding discussed above. In November 2010, the district court in the MDL proceeding remanded the case to Arkansas state court. In December 2011, the plaintiffs voluntarily dismissed their claims against Altria Group, Inc. without prejudice.

The Price Case

Trial in the Price case commenced in state court in Illinois in January 2003, and in March 2003, the judge found in favor of the plaintiff class and awarded $7.1 billion in compensatory damages and $3 billion in punitive damages against PM USA. In December 2005, the Illinois Supreme Court reversed the trial court’s judgment in favor of the

 

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plaintiffs. In November 2006, the United States Supreme Court denied plaintiffs’ petition for writ of certiorari and, in December 2006, the Circuit Court of Madison County enforced the Illinois Supreme Court’s mandate and dismissed the case with prejudice.

In December 2008, plaintiffs filed with the trial court a petition for relief from the final judgment that was entered in favor of PM USA. Specifically, plaintiffs sought to vacate the judgment entered by the trial court on remand from the 2005 Illinois Supreme Court decision overturning the verdict on the ground that the United States Supreme Court’s December 2008 decision in Good demonstrated that the Illinois Supreme Court’s decision was “inaccurate.” PM USA filed a motion to dismiss plaintiffs’ petition and, in February 2009, the trial court granted PM USA’s motion on the basis that the petition was not timely filed. In March 2009, the Price plaintiffs filed a notice of appeal with the Fifth Judicial District of the Appellate Court of Illinois. In February 2011, the intermediate appellate court ruled that the petition was timely filed and reversed the trial court’s dismissal of the plaintiffs’ petition and, in September 2011, the Illinois Supreme Court declined PM USA’s petition for review. As a result, the case has returned to the trial court for proceedings on whether the court should grant the plaintiffs’ petition to reopen the prior judgment. On February 15, 2012, plaintiffs filed an amended petition, which PM USA opposes. A hearing on PM USA’s opposition to plaintiffs’ amended petition is scheduled for May 22, 2012.

In June 2009, the plaintiff in an individual smoker lawsuit (Kelly) brought on behalf of an alleged smoker of “Lights” cigarettes in Madison County, Illinois state court filed a motion seeking a declaration that his claims under the Illinois Consumer Fraud Act are not (1) barred by the exemption in that statute based on his assertion that the Illinois Supreme Court’s decision in Price is no longer good law in light of the decisions by the United States Supreme Court in Good and Watson, and (2) preempted in light of the United States Supreme Court’s decision in Good. In September 2009, the court granted plaintiff’s motion as to federal preemption, but denied it with respect to the state statutory exemption.

State Trial Court Class Certifications

State trial courts have certified classes against PM USA in Massachusetts (Aspinall), Minnesota (Curtis), Missouri (Larsen) and New Hampshire (Lawrence). Significant developments in these cases include:

 

   

Aspinall: In August 2004, the Massachusetts Supreme Judicial Court affirmed the class certification order. In August 2006, the trial court denied PM USA’s motion for summary judgment and granted plaintiffs’ motion for summary judgment on the defenses of federal preemption and a state law exemption to Massachusetts’ consumer protection statute. On motion of the parties, the trial court subsequently reported its decision to deny summary judgment to the appeals court for review and stayed further proceedings pending completion of the appellate review. In December 2008, subsequent to the United States Supreme Court’s decision in Good, the Massachusetts Supreme Judicial Court issued an order requesting that the parties advise the court within 30 days whether the Good decision is dispositive of federal preemption issues pending on appeal. In January 2009, PM USA notified the Massachusetts Supreme Judicial Court that Good is dispositive of the federal preemption issues on appeal, but requested further briefing on the state law statutory exemption issue. In March 2009, the Massachusetts Supreme Judicial Court affirmed the order denying summary judgment to PM USA and granting the plaintiffs’ cross-motion. In January 2010, plaintiffs moved for partial summary judgment as to liability claiming collateral estoppel from the findings in the case brought by the Department of Justice (see Federal Government’s Lawsuit described above). On March 13, 2012, the trial court denied plaintiffs’ motion.

 

   

Curtis: In April 2005, the Minnesota Supreme Court denied PM USA’s petition for interlocutory review of the trial court’s class certification order. In October 2009, the trial court denied plaintiffs’ motion for partial summary judgment, filed in February 2009, claiming collateral estoppel from the findings in the case brought by the Department of Justice (see Federal Government’s Lawsuit described above). In October 2009, the trial court granted PM USA’s motion for partial summary judgment as to all consumer protection counts and, in December 2009, dismissed the case in its entirety. In December 2010, the Minnesota Court of Appeals reversed the trial court’s dismissal of the case and affirmed the trial court’s prior certification of the class under Minnesota’s consumer protection statutes. The Court of Appeals also affirmed the trial court’s denial of the plaintiffs’ motion for partial summary judgment claiming collateral estoppel from the findings in the case brought by the Department of Justice. PM USA’s petition for review with the Minnesota Supreme Court was granted in March 2011. Argument on the petition was heard in September 2011.

 

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Larsen: In August 2005, a Missouri Court of Appeals affirmed the class certification order. In December 2009, the trial court denied plaintiffs’ motion for reconsideration of the period during which potential class members can qualify to become part of the class. The class period remains 1995 – 2003. In June 2010, PM USA’s motion for partial summary judgment regarding plaintiffs’ request for punitive damages was denied. In April 2010, plaintiffs moved for partial summary judgment as to an element of liability in the case, claiming collateral estoppel from the findings in the case brought by the Department of Justice (see Federal Government’s Lawsuit described above). The plaintiffs’ motion was denied in December 2010. In June 2011, PM USA filed various summary judgment motions challenging the plaintiffs’ claims. In August 2011, the trial court granted PM USA’s motion for partial summary judgment, ruling that plaintiffs could not present a damages claim based on allegations that Marlboro Lights are more dangerous than Marlboro Reds. The trial court denied PM USA’s remaining summary judgment motions. Trial in the case began in September 2011 and, in October 2011 the court declared a mistrial after the jury failed to reach a verdict. The court has scheduled a new trial to begin on January 21, 2013.

 

   

Lawrence: In November 2010, the trial court certified a class consisting of all persons who purchased Marlboro Lights cigarettes in the state of New Hampshire at any time from the date the brand was introduced into commerce until the date trial in the case begins. PM USA’s motion for reconsideration of this decision was denied in January 2011. In September 2011, the New Hampshire Supreme Court accepted review of the class certification decision. Argument is scheduled for June 7, 2012.

Certain Other Tobacco-Related Litigation

Tobacco Price Case: As of April 23, 2012, one case remains pending in Kansas (Smith) in which plaintiffs allege that defendants, including PM USA and Altria Group, Inc., conspired to fix cigarette prices in violation of antitrust laws. Plaintiffs’ motion for class certification has been granted. On March 26, 2012, the trial court granted defendants’ motions for summary judgment.

Case Under the California Business and Professions Code: In June 1997, a lawsuit (Brown) was filed in California state court alleging that domestic cigarette manufacturers, including PM USA and others, have violated California Business and Professions Code Sections 17200 and 17500 regarding unfair, unlawful and fraudulent business practices. Class certification was granted as to plaintiffs’ claims that class members are entitled to reimbursement of the costs of cigarettes purchased during the class periods and injunctive relief. In September 2004, the trial court granted defendants’ motion for summary judgment as to plaintiffs’ claims attacking defendants’ cigarette advertising and promotion and denied defendants’ motion for summary judgment on plaintiffs’ claims based on allegedly false affirmative statements. In March 2005, the court granted defendants’ motion to decertify the class based on a California law, which inter alia limits the ability to bring a lawsuit to only those plaintiffs who have “suffered injury in fact” and “lost money or property” as a result of defendants’ alleged statutory violations (“Proposition 64”).

In September 2006, an intermediate appellate court affirmed the trial court’s order decertifying the class. In May 2009, the California Supreme Court reversed the trial court decision that was affirmed by the appellate court and remanded the case to the trial court. In March 2010, the trial court granted reconsideration of its September 2004 order granting partial summary judgment to defendants with respect to plaintiffs’ “Lights” claims on the basis of judicial decisions issued since its order was issued, including the United States Supreme Court’s ruling in Good, thereby reinstating plaintiffs’ “Lights” claims. Since the trial court’s prior ruling decertifying the class was reversed on appeal by the California Supreme Court, the parties and the court are treating all claims currently being asserted by the plaintiffs as certified, subject, however, to defendants’ challenge to the class representatives’ standing to assert their claims. The class is defined as people who, at the time they were residents of California, smoked in California one or more cigarettes between June 10, 1993 and April 23, 2001, and who were exposed to defendants’ marketing and advertising activities in California.

In July 2010, plaintiffs filed a motion seeking collateral estoppel effect from the findings in the case brought by the Department of Justice (see Federal Government’s Lawsuit described above). In September 2010, plaintiffs filed a motion for preliminary resolution of legal issues regarding restitutionary relief. The trial court denied both of plaintiffs’ motions in November 2010. In November 2010, defendants filed a motion seeking a determination that Brown class members who were also part of the class in Daniels (a previously disclosed consumer fraud case in which

 

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the California Supreme Court affirmed summary judgment in PM USA’s favor based on preemption and First Amendment grounds) are precluded by the Daniels judgment from recovering in Brown. This motion was denied in December 2010. Defendants sought review of this decision before the Fourth District Court of Appeal but were denied review in March 2011. In January 2012, defendants filed motions for a determination that the class representatives lack standing and are not typical or adequate to represent the class and to decertify the class. Argument is scheduled for May 2, 2012. Trial is currently scheduled for October 5, 2012.

Ignition Propensity Cases: PM USA is currently facing litigation in which plaintiffs contend that fires caused by cigarettes led to other individuals’ deaths. In one case filed in federal court in Massachusetts (Sarro), the district court in August 2009 granted in part PM USA’s motion to dismiss, but ruled that two claims unrelated to product design could go forward. In November 2010, PM USA filed a motion for summary judgment, which motion was granted on March 7, 2012. Plaintiffs have agreed not to appeal the summary judgment ruling in exchange for PM USA’s waiver of costs, concluding this litigation. In a Kentucky case (Walker), the federal district court denied plaintiffs’ motion to remand the case to state court and dismissed plaintiffs’ claims in February 2009. Plaintiffs subsequently filed a notice of appeal. In October 2011, the United States Court of Appeals for the Sixth Circuit reversed the portion of the district court decision that denied remand of the case to Kentucky state court and remanded the case to Kentucky state court. The Sixth Circuit did not address the merits of the district court’s dismissal order. Defendants’ petition for rehearing with the Sixth Circuit was denied in December 2011.

False Claims Act Case: PM USA and Altria Group, Inc. were served on January 27, 2012 in a qui tam action filed in the United States District Court for the District of Columbia (United States ex rel. Oliver) alleging violation of the False Claims Act in connection with sales of cigarettes to the U.S. military for resale on U.S. military bases overseas. The relator contends that PM USA wrongfully included the per-carton cost of MSA payments in the list price charged to government agencies that purchased cigarettes from PM USA in the United States for resale on overseas military bases, and that, as a result, non-military civilian customers overseas allegedly received lower pricing on cigarettes sold in those overseas markets than the government agencies. The United States declined to intervene in the action on September 13, 2011.

Argentine Grower Case: PM USA and Altria Group, Inc. are defendants in a case (Hupan) filed in Delaware state court against multiple defendants by the parents of several minor Argentine children born with alleged birth defects. Plaintiffs allege that they grew tobacco in Argentina under contract with Tabacos Norte S.A., an alleged subsidiary of PMI, and that they and their infant children were exposed directly and in utero to hazardous herbicides and pesticides used in the production and cultivation of tobacco. Plaintiffs seek compensatory and punitive damages against all defendants under U.S. and Argentine law. Altria Group, Inc. and PMI are in discussions regarding indemnification for this case pursuant to the Distribution Agreement between the parties. See Guarantees for a discussion of the Distribution Agreement.

UST Litigation

Claims related to smokeless tobacco products generally fall within the following categories:

First, UST and/or its tobacco subsidiaries has been named in certain actions in West Virginia (See In re: Tobacco Litigation above) brought on behalf of individual plaintiffs against cigarette manufacturers, smokeless tobacco manufacturers, and other organizations seeking damages and other relief in connection with injuries allegedly sustained as a result of tobacco usage, including smokeless tobacco products. Included among the plaintiffs are five individuals alleging use of USSTC’s smokeless tobacco products and alleging the types of injuries claimed to be associated with the use of smokeless tobacco products. USSTC, along with other non-cigarette manufacturers, has remained severed from such proceedings since December 2001.

Second, UST and/or its tobacco subsidiaries has been named in a number of other individual tobacco and health suits. Plaintiffs’ allegations of liability in these cases are based on various theories of recovery, such as negligence, strict liability, fraud, misrepresentation, design defect, failure to warn, breach of implied warranty, addiction, and breach of consumer protection statutes. Plaintiffs seek various forms of relief, including compensatory and punitive damages, and certain equitable relief, including but not limited to disgorgement. Defenses raised in these cases include lack of causation, assumption of the risk, comparative fault and/or contributory negligence, and statutes of limitations. USSTC is currently named in one such action in Florida (Vassallo).

 

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Certain Other Actions

IRS Challenges to PMCC Leases

Background. The IRS has concluded its examination of Altria Group, Inc.’s consolidated federal income tax returns for the years 1996 through 2003, and for each year has disallowed tax benefits pertaining to certain leveraged lease transactions entered into by PMCC (referred to by the IRS as lease-in/lease-out (“LILO”) and sale-in/lease-out (“SILO”) transactions). For financial reporting purposes, PMCC accounted for LILO and SILO transactions as leveraged lease transactions under the guidance in Accounting Standards Codification (“ASC”) 840, Leases (“ASC 840”). For income tax purposes, PMCC treated these transactions as leases under case law and applicable IRS administrative guidance for the 1996 through 2009 tax years.

Refund Claims and Litigation. Altria Group, Inc. believes that its tax treatment of PMCC’s LILO and SILO transactions on federal and state income tax returns for the 1996 through 2009 tax years was proper and complied with applicable tax laws in effect during the relevant periods. Altria Group, Inc. has contested the disallowances for the 1996 through 2003 tax years, filed claims for refunds of federal income tax and associated interest paid and pursued or is pursuing refund litigation in federal court with respect to certain of the refund claims, as discussed below.

In October 2006, Altria Group, Inc. filed a complaint in the United States District Court for the Southern District of New York to claim a refund on a portion of these federal income tax payments and associated interest for the years 1996 and 1997, attributable to LILO and SILO transactions entered into during those years. In July 2009, the jury returned a unanimous verdict in favor of the IRS and, in April 2010, after denying Altria Group, Inc.’s post-trial motions, the district court entered final judgment in favor of the IRS. Altria Group, Inc. filed an appeal with the United States Court of Appeals for the Second Circuit in June 2010. In September 2011, the Second Circuit affirmed the district court decision in favor of the IRS. Altria Group, Inc. has elected not to pursue further judicial review of its refund claim for the 1996 and 1997 transactions.

In March 2008, Altria Group, Inc. filed a second complaint in the United States District Court for the Southern District of New York seeking a refund of the federal income tax payments and associated interest for the years 1998 and 1999 attributable to the disallowance of tax benefits claimed in those years with respect to the LILO and SILO transactions subject to the jury verdict and with respect to the additional LILO and SILO transactions entered into in 1998 and 1999. In May 2009, the district court granted a stay pending the decision by the United States Court of Appeals for the Second Circuit in the appeal involving the 1996 and 1997 transactions. Following Altria Group, Inc.’s decision not to pursue further judicial review of its refund claim regarding the 1996 and 1997 transactions, the case for the 1998 and 1999 years has been reactivated.

In March 2011, Altria Group, Inc. filed claims for a refund with the IRS for the years 2000 through 2003 of the tax and associated interest paid with respect to the LILO and SILO transactions that PMCC entered into during the 1996-2003 years. The IRS disallowed the claims in July 2011, and Altria Group, Inc. intends to commence litigation in federal court.

In a closing agreement entered into in May 2010, Altria Group, Inc. and the IRS agreed that, with the exception of the LILO and SILO transactions, the tax treatment reported by Altria Group, Inc. on its consolidated federal income tax returns for the 2000-2003 years, as amended by the agreed-upon adjustments in the closing agreement, is appropriate and final. The IRS may not assess against Altria Group, Inc. any further taxes or additions to tax (including penalties) with respect to these years.

As a prerequisite to commencing in federal court the refund litigation described above following the IRS disallowance of tax benefits of the LILO and SILO transactions for the 1996-1999 audit cycle, in 2006 Altria Group, Inc. paid approximately $150 million related to disallowed tax benefits and associated interest. Similarly, following the IRS disallowance of tax benefits of the LILO and SILO transactions for the 2000-2003 audit cycle, also described above, in 2010, Altria Group, Inc. paid approximately $945 million in disallowed tax benefits and associated interest in order to pursue its legal challenge to the disallowances in federal court.

Payments to the IRS. As indicated in “Refund Claims and Litigation” above, Altria Group, Inc. has paid a total of approximately $1.1 billion in federal income tax payments and interest with respect to the LILO and SILO transactions for the 1996 through 2003 tax years. The tax component of this amount represents an acceleration of taxes that Altria Group, Inc. would have otherwise paid over the later stages of the LILO and SILO transactions. Altria Group, Inc.

 

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treated the amounts paid to the IRS for these years as deposits for financial reporting purposes pending the ultimate outcomes of the litigation. Altria Group, Inc. included such amounts in Other assets on its consolidated balance sheets. As a result of its decision not to pursue further judicial review of its refund claims for the 1996 and 1997 transactions, Altria Group, Inc. reduced both Other assets and tax liabilities on its December 31, 2011 consolidated balance sheet by approximately $362 million, which is the amount of taxes and interest that Altria Group, Inc. has previously paid related to the 1996 and 1997 transactions for the 1996 through 2003 tax years. The impact of these payments on Altria Group, Inc.’s earnings has previously been recorded on its financial statements, as discussed below. If Altria Group, Inc. were to prevail in the current and/or anticipated refund litigation, it would receive a refund of the remaining amounts paid to the IRS plus interest. If the IRS’s position with respect to the LILO and SILO transactions is ultimately sustained, Altria Group, Inc. would further reduce its tax liabilities and the asset discussed above.

Anticipated Future Disallowances and Additional Payments to the IRS. Altria Group, Inc. further expects the IRS and impacted states to disallow income tax benefits claimed in years 2004 through 2009 related to the LILO and SILO transactions that PMCC entered into from 1996 through 2003. The disallowance of federal and state income tax benefits for the 2004 through 2009 tax years and associated interest through March 31, 2012 would result in additional payments of approximately $600 million, excluding potential penalties. The tax component of this amount represents an acceleration of taxes that Altria Group, Inc. would have otherwise paid over the later stages of the LILO and SILO transactions. This amount is net of federal and state income taxes paid on gains associated with sales of leased assets from January 1, 2008 through March 31, 2012. Although the initial amount payable may be greater than $600 million, such taxes paid on gains associated with sales of leased assets will be subsequently recovered no later than the closing of the audits for the cycles in which the sales have occurred. The payments of disallowed tax benefits, if any, would depend upon the timing and outcome of future IRS audits and any related administrative challenges or litigation. The IRS is currently auditing the 2004-2006 tax years.

2010 and Future Tax Years. Altria Group, Inc. did not claim tax benefits pertaining to PMCC’s LILO and SILO transactions on its federal and state income tax returns for 2010 and, at this time, does not intend to claim such tax benefits in future years. Altria Group, Inc., however, intends to preserve its right to file amended returns for these years claiming the tax benefits pertaining to PMCC’s LILO and SILO transactions if Altria Group, Inc. is successful in the current and/or anticipated litigation discussed above.

Second Quarter 2011 Earnings Charge. Altria Group, Inc. has continually re-evaluated the likelihood of sustaining its tax position on PMCC’s LILO and SILO transactions, as required by ASC 740, Income Taxes (“ASC 740”). In the second quarter of 2011, in accordance with ASC 840 and ASC 740, Altria Group, Inc. recorded a one-time charge of $627 million against its 2011 reported earnings related to the tax treatment of the LILO and SILO transactions that PMCC entered into between 1996 and 2003. Altria Group, Inc.’s decision to record the charge was based on the Federal Circuit’s April 2011 adverse decision in Wells Fargo & Co. v. United States, involving SILO transactions entered into by another taxpayer. Altria Group, Inc. concluded that the decision introduced incremental risk to its tax analysis and, as a result, that it was no longer more likely than not that it would prevail in its defense of its tax position on PMCC’s LILO and SILO transactions.

The charge of $627 million reflects the re-characterization of PMCC’s LILO and SILO transactions as loans (as opposed to leases) for income tax purposes, which changes the timing of income recognition for tax purposes over the term of the deemed loan. This change, in turn, impacts the income of the leases recorded pursuant to leveraged lease accounting (ASC 840) resulting in a lowering of the cumulative income from the transactions that had been recorded from inception of the transactions to the date of the charge. This earnings charge is incremental to $146 million recorded as a reduction to stockholders’ equity upon the adoption of new accounting standards for leases (“FAS 13-2”) and for uncertainty in income taxes (“FIN 48”) on January 1, 2007, and approximately $95 million recorded to the statements of earnings from January 1, 2007 through March 31, 2011. In quantifying the reduction in cumulative leveraged lease income to include in the second quarter 2011 earnings charge, Altria Group, Inc. was required to make assumptions regarding a potential settlement of these matters with the IRS. To the extent the assumptions change, there may be additional impact on Altria Group, Inc.’s earnings but Altria Group, Inc. does not expect such impact, if any, to be significant.

Approximately 50% of the $627 million charge represents the effects of re-characterization of the transactions as loans and the resulting reduction in cumulative leveraged lease income described above. This reduction in income will be recaptured over the remaining terms of the respective transactions. The remaining portion of the charge primarily

 

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represents a permanent charge for interest on tax underpayments. The charge does not include potential penalties as Altria Group, Inc. believes that it met the applicable standards to avoid any associated penalties at the time it claimed the deductions on its tax returns.

As of March 31, 2012, the LILO and SILO transactions represented approximately 27% of the Net Finance Assets of PMCC’s lease portfolio. PMCC has not entered into any LILO or SILO transactions since 2003.

Kraft Thrift Plan Cases: Four participants in the Kraft Foods Global, Inc. Thrift Plan (“Kraft Thrift Plan”), a defined contribution plan, filed a class action complaint (George II) on behalf of all participants and beneficiaries of the Kraft Thrift Plan in July 2008 in the United States District Court for the Northern District of Illinois alleging breach of fiduciary duty under the Employee Retirement Income Security Act (“ERISA”). Named defendants in this action include Altria Corporate Services, Inc. (now Altria Client Services Inc.) and certain company committees that allegedly had a relationship to the Kraft Thrift Plan. Plaintiffs request, among other remedies, that defendants restore to the Kraft Thrift Plan all losses improperly incurred.

In December 2009, the court granted in part and denied in part defendants’ motion to dismiss plaintiffs’ complaint. In addition to dismissing certain claims made by plaintiffs for equitable relief under ERISA as to all defendants, the court dismissed claims alleging excessive administrative fees and mismanagement of company stock funds as to one of the Altria Group, Inc. defendants. In February 2010, the court granted a joint stipulation dismissing the fee and stock fund claims without prejudice as to the remaining defendants, including Altria Client Services Inc. Accordingly, the only claim remaining at this time in George II relates to the alleged negligence of plan fiduciaries for including the Growth Equity Fund and Balanced Fund as Kraft Thrift Plan investment options. Plaintiffs filed a motion for class certification in March 2010, which the court granted in August 2010. Defendants filed a motion for summary judgment in January 2011, and plaintiffs filed a motion for partial summary judgment. In March 2011, defendants filed a motion to vacate the class certification in light of recent federal judicial precedent. In July 2011, the court granted defendants’ summary judgment motion in part, finding that claims for periods prior to July 2, 2002 were time barred, and that the defendants properly monitored the funds. The court also denied plaintiffs’ motion for partial summary judgment. Remaining in the case are claims after July 2, 2002 relating to whether it was prudent to retain actively managed investments (Growth Equity Fund and Balanced Fund) in the Kraft Thrift Plan after 1999. In July 2011, the court also granted defendants’ motion to vacate the class certification, and allowed plaintiffs leave to file a new motion for class certification in light of recent precedent and the court’s summary judgment findings. Plaintiffs’ motion to certify the class is pending before the court.

In August 2011, Altria Client Services Inc. and a company committee that allegedly had a relationship to the Kraft Thrift Plan were added as defendants in another class action previously brought by the same plaintiffs in 2006 (George I), in which plaintiffs allege defendants breached their fiduciary duties under ERISA by offering company stock funds in a unitized format and by allegedly overpaying for recordkeeping services.

The parties have reached a proposed class-wide settlement. On March 5, 2012, the court administratively dismissed the suit. The proposed settlement, which does not require any payment by the Altria Group, Inc. defendants, is subject to court approval, which is pending. Under the terms of a Distribution Agreement between Altria Group, Inc. and Kraft Foods Inc., the Altria Group, Inc. defendants may be entitled to indemnity against any liabilities incurred in connection with these cases.

California Wage and Hour Case

In September 2011, two former sales representatives employed in California by Altria Group Distribution Company (“AGDC”) filed a putative class action in the United States District Court for the Northern District of California, under California’s wage and hour laws. The named plaintiffs seek to represent a class of all former sales representatives who worked for AGDC in California at any time since September 2007. The plaintiffs seek overtime pay, recovery of certain wages, reimbursement of business expenses and other non-monetary relief and penalties. In November 2011, the plaintiffs amended their complaint to add an additional claim for penalties under California’s Private Attorney General Act. On January 6, 2012, AGDC moved to dismiss certain of plaintiffs’ claims and to transfer the case from the Northern District of California to the Central District of California. On February 22, 2012, the district court granted the motion to transfer, and the case was transferred to the Central District of California on March 7, 2012. The motion to dismiss remains pending before the United States District Court for the Central District of California.

 

-45-


Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Environmental Regulation

Altria Group, Inc. and its subsidiaries (and former subsidiaries) are subject to various federal, state and local laws and regulations concerning the discharge of materials into the environment, or otherwise related to environmental protection, including, in the United States: The Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act and the Comprehensive Environmental Response, Compensation and Liability Act (commonly known as “Superfund”), which can impose joint and several liability on each responsible party. Subsidiaries (and former subsidiaries) of Altria Group, Inc. are involved in several matters subjecting them to potential costs of remediation and natural resource damages under Superfund or other laws and regulations. Altria Group, Inc.’s subsidiaries expect to continue to make capital and other expenditures in connection with environmental laws and regulations. Altria Group, Inc. provides for expenses associated with environmental remediation obligations on an undiscounted basis when such amounts are probable and can be reasonably estimated. Such accruals are adjusted as new information develops or circumstances change. Other than those amounts, it is not possible to reasonably estimate the cost of any environmental remediation and compliance efforts that subsidiaries of Altria Group, Inc. may undertake in the future. In the opinion of management, however, compliance with environmental laws and regulations, including the payment of any remediation costs or damages and the making of related expenditures, has not had, and is not expected to have, a material adverse effect on Altria Group, Inc.’s consolidated results of operations, capital expenditures, financial position or cash flows.

Guarantees

In the ordinary course of business, certain subsidiaries of Altria Group, Inc. have agreed to indemnify a limited number of third parties in the event of future litigation. At March 31, 2012, subsidiaries of Altria Group, Inc. were also contingently liable for $32 million of guarantees related to their own performance, consisting primarily of surety bonds. These items have not had, and are not expected to have, a significant impact on Altria Group, Inc.’s liquidity.

Under the terms of the Distribution Agreement between Altria Group, Inc. and PMI, entered into as a result of Altria Group, Inc.’s 2008 spin-off of its former subsidiary PMI, liabilities concerning tobacco products will be allocated based in substantial part on the manufacturer. PMI will indemnify Altria Group, Inc. and PM USA for liabilities related to tobacco products manufactured by PMI or contract manufactured for PMI by PM USA, and PM USA will indemnify PMI for liabilities related to tobacco products manufactured by PM USA, excluding tobacco products contract manufactured for PMI. Altria Group, Inc. does not have a related liability recorded on its condensed consolidated balance sheet at March 31, 2012 as the fair value of this indemnification is insignificant.

As more fully discussed in Note 11. Condensed Consolidating Financial Information, PM USA has issued guarantees relating to Altria Group, Inc.’s obligations under its outstanding debt securities, borrowings under its senior unsecured 5-year revolving credit agreement (the “Credit Agreement”) and amounts outstanding under its commercial paper program.

Redeemable Noncontrolling Interest

In September 2007, Ste. Michelle completed the acquisition of Stag’s Leap Wine Cellars through one of its consolidated subsidiaries, Michelle-Antinori, LLC (“Michelle-Antinori”), in which Ste. Michelle holds an 85% ownership interest with a 15% noncontrolling interest held by Antinori California (“Antinori”). In connection with the acquisition of Stag’s Leap Wine Cellars, Ste. Michelle entered into a put arrangement with Antinori. The put arrangement, as later amended, provides Antinori with the right to require Ste. Michelle to purchase its 15% ownership interest in Michelle-Antinori at a price equal to Antinori’s initial investment of $27 million. The put arrangement became exercisable on September 11, 2010 and has no expiration date. As of March 31, 2012, the redemption value of the put arrangement did not exceed the noncontrolling interest balance. Therefore, no adjustment to the value of the redeemable noncontrolling interest was recognized on the condensed consolidated balance sheet for the put arrangement.

The noncontrolling interest put arrangement is accounted for as mandatorily redeemable securities because redemption is outside of the control of Ste. Michelle. As such, the redeemable noncontrolling interest is reported in the mezzanine equity section on the condensed consolidated balance sheets at March 31, 2012 and December 31, 2011.

 

-46-


Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 11. Condensed Consolidating Financial Information:

PM USA, which is a wholly-owned subsidiary of Altria Group, Inc., has issued guarantees relating to Altria Group, Inc.’s obligations under its outstanding debt securities, borrowings under its Credit Agreement and amounts outstanding under its commercial paper program (the “Guarantees”). Pursuant to the Guarantees, PM USA fully and unconditionally guarantees, as primary obligor, the payment and performance of Altria Group, Inc.’s obligations under the guaranteed debt instruments (the “Obligations”), subject to release under certain customary circumstances as noted below.

The Guarantees provide that PM USA guarantees the punctual payment when due, whether at stated maturity, by acceleration or otherwise, of the Obligations. The liability of PM USA under the Guarantees is absolute and unconditional irrespective of: any lack of validity, enforceability or genuineness of any provision of any agreement or instrument relating thereto; any change in the time, manner or place of payment of, or in any other term of, all or any of the Obligations, or any other amendment or waiver of or any consent to departure from any agreement or instrument relating thereto; any exchange, release or non-perfection of any collateral, or any release or amendment or waiver of or consent to departure from any other guarantee, for all or any of the Obligations; or any other circumstance that might otherwise constitute a defense available to, or a discharge of, Altria Group, Inc. or PM USA.

The obligations of PM USA under the Guarantees are limited to the maximum amount as will, after giving effect to such maximum amount and all other contingent and fixed liabilities of PM USA that are relevant under Bankruptcy Law, the Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act or any similar federal or state law to the extent applicable to the Guarantees, result in PM USA’s obligations under the Guarantees not constituting a fraudulent transfer or conveyance. For this purpose, “Bankruptcy Law” means Title 11, U.S. Code, or any similar federal or state law for the relief of debtors.

PM USA will be unconditionally released and discharged from its obligations under each of the Guarantees upon the earliest to occur of:

 

   

the date, if any, on which PM USA consolidates with or merges into Altria Group, Inc. or any successor;

 

   

the date, if any, on which Altria Group, Inc. or any successor consolidates with or merges into PM USA;

 

   

the payment in full of the Obligations pertaining to such Guarantees; and

 

   

the rating of Altria Group, Inc.’s long-term senior unsecured debt by Standard & Poor’s of A or higher.

At March 31, 2012, the respective principal wholly-owned subsidiaries of Altria Group, Inc. and PM USA were not limited by long-term debt or other agreements in their ability to pay cash dividends or make other distributions with respect to their common stock.

The following sets forth the condensed consolidating balance sheets as of March 31, 2012 and December 31, 2011, condensed consolidating statements of earnings and comprehensive earnings for the three months ended March 31, 2012 and 2011, and condensed consolidating statements of cash flows for the three months ended March 31, 2012 and 2011 for Altria Group, Inc., PM USA and Altria Group, Inc.’s other subsidiaries that are not guarantors of Altria Group, Inc.’s debt instruments (the “Non-Guarantor Subsidiaries”). The financial information is based on Altria Group, Inc.’s understanding of the SEC interpretation and application of Rule 3-10 of SEC Regulation S-X.

The financial information may not necessarily be indicative of results of operations or financial position had PM USA and the Non-Guarantor Subsidiaries operated as independent entities. Altria Group, Inc. and PM USA account for investments in their subsidiaries under the equity method of accounting.

Certain prior-period amounts have been recast to conform with the current-period presentation, due to Middleton becoming a wholly-owned subsidiary of PM USA effective January 1, 2012.

 

-47-


Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Condensed Consolidating Balance Sheets

March 31, 2012

(in millions of dollars)

 

      Altria
Group, Inc.
     PM USA      Non-
Guarantor
Subsidiaries
     Total
Consolidating
Adjustments
    Consolidated  

Assets

             

Consumer products

             

Cash and cash equivalents

   $ 4,140       $ —         $ 16       $ —        $ 4,156   

Receivables

     164         14         66           244   

Inventories:

             

Leaf tobacco

        556         376           932   

Other raw materials

        128         50           178   

Work in process

        9         301           310   

Finished product

        180         230           410   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
        873         957           1,830   

Due from Altria Group, Inc. and subsidiaries

     709         4,419         1,458         (6,586  

Deferred income taxes

     9         1,157         41           1,207   

Other current assets

     249         345         105         (243     456   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total current assets

     5,271         6,808         2,643         (6,829     7,893   

Property, plant and equipment, at cost

     2         3,293         1,442           4,737   

Less accumulated depreciation

     2         2,046         524           2,572   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
        1,247         918           2,165   

Goodwill

           5,174           5,174   

Other intangible assets, net

        2         12,091           12,093   

Investment in SABMiller

     5,965                 5,965   

Investment in consolidated subsidiaries

     9,085         3,029            (12,114  

Due from Altria Group, Inc. and subsidiaries

     4,500               (4,500  

Other assets

     947         570         99         (381     1,235   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total consumer products assets

     25,768         11,656         20,925         (23,824     34,525   

Financial services

             

Finance assets, net

           3,247           3,247   

Due from Altria Group, Inc. and subsidiaries

           628         (628  

Other assets

           43           43   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total financial services assets

           3,918         (628     3,290   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total Assets

   $ 25,768       $ 11,656       $ 24,843       $ (24,452   $ 37,815   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

-48-


Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Condensed Consolidating Balance Sheets (Continued)

March 31, 2012

(in millions of dollars)

 

      Altria
Group, Inc.
    PM USA     Non-
Guarantor
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Liabilities

          

Consumer products

          

Current portion of long-term debt

   $ —        $ —        $ 600      $ —        $ 600   

Accounts payable

     69        125        134          328   

Accrued liabilities:

          

Marketing

       456        18          474   

Taxes, except income taxes

       265        15          280   

Employment costs

     23        7        45          75   

Settlement charges

       4,532        6          4,538   

Other

     389        543        406          1,338   

Income taxes

       495        57        (243     309   

Dividends payable

     839              839   

Due to Altria Group, Inc. and subsidiaries

     5,545        337        1,332        (7,214  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current liabilities

     6,865        6,760        2,613        (7,457     8,781   

Long-term debt

     12,790          299          13,089   

Deferred income taxes

     1,947          3,366        (381     4,932   

Accrued pension costs

     237          917          1,154   

Accrued postretirement health care costs

       1,561        806          2,367   

Due to Altria Group, Inc. and subsidiaries

         4,500        (4,500  

Other liabilities

     228        211        151          590   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer products liabilities

     22,067        8,532        12,652        (12,338     30,913   

Financial services

          

Deferred income taxes

         2,514          2,514   

Other liabilities

         652          652   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial services liabilities

         3,166          3,166   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

     22,067        8,532        15,818        (12,338     34,079   

Contingencies

          

Redeemable noncontrolling interest

         32          32   

Stockholders’ Equity

          

Common stock

     935          9        (9     935   

Additional paid-in capital

     5,633        3,321        10,212        (13,533     5,633   

Earnings reinvested in the business

     23,720        116        397        (513     23,720   

Accumulated other comprehensive losses

     (1,685     (313     (1,628     1,941        (1,685

Cost of repurchased stock

     (24,902           (24,902
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stockholders’ equity attributable to Altria Group, Inc.

     3,701        3,124        8,990        (12,114     3,701   

Noncontrolling interests

         3          3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stockholders’ equity

     3,701        3,124        8,993        (12,114     3,704   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 25,768      $ 11,656      $ 24,843      $ (24,452   $ 37,815   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

-49-


Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Condensed Consolidating Balance Sheets

December 31, 2011

(in millions of dollars)

 

     Altria
Group, Inc.
     PM USA      Non-
Guarantor
Subsidiaries
     Total
Consolidating
Adjustments
    Consolidated  

Assets

             

Consumer products

             

Cash and cash equivalents

   $ 3,245       $ —         $ 25       $ —        $ 3,270   

Receivables

     174         16         78           268   

Inventories:

             

Leaf tobacco

        565         369           934   

Other raw materials

        128         42           170   

Work in process

        4         312           316   

Finished product

        126         233           359   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
        823         956           1,779   

Due from Altria Group, Inc. and subsidiaries

     403         3,007         1,765         (5,175  

Deferred income taxes

     9         1,157         41           1,207   

Other current assets

     6         430         247         (76     607   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total current assets

     3,837         5,433         3,112         (5,251     7,131   

Property, plant and equipment, at cost

     2         3,280         1,446           4,728   

Less accumulated depreciation

     2         2,005         505           2,512   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
        1,275         941           2,216   

Goodwill

           5,174           5,174   

Other intangible assets, net

        2         12,096           12,098   

Investment in SABMiller

     5,509                 5,509   

Investment in consolidated subsidiaries

     7,009         3,035            (10,044  

Due from Altria Group, Inc. and subsidiaries

     6,500               (6,500  

Other assets

     941         586         111         (381     1,257   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total consumer products assets

     23,796         10,331         21,434         (22,176     33,385   

Financial services

             

Finance assets, net

           3,559           3,559   

Due from Altria Group, Inc. and subsidiaries

           292         (292  

Other assets

           18           18   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total financial services assets

           3,869         (292     3,577   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total Assets

   $ 23,796       $ 10,331       $ 25,303       $ (22,468   $ 36,962   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

-50-


Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Condensed Consolidating Balance Sheets (Continued)

December 31, 2011

(in millions of dollars)

 

     Altria
Group, Inc.
    PM USA     Non-
Guarantor
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Liabilities

          

Consumer products

          

Current portion of long-term debt

   $ —        $ —        $ 600      $ —        $ 600   

Accounts payable

     69        159        275          503   

Accrued liabilities:

          

Marketing

       390        40          430   

Taxes, except income taxes

       209        11          220   

Employment costs

     29        12        184          225   

Settlement charges

       3,508        5          3,513   

Other

     384        620        383        (76     1,311   

Dividends payable

     841              841   

Due to Altria Group, Inc. and subsidiaries

     3,792        474        1,201        (5,467  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current liabilities

     5,115        5,372        2,699        (5,543     7,643   

Long-term debt

     12,790          299          13,089   

Deferred income taxes

     1,787          3,345        (381     4,751   

Accrued pension costs

     236          1,426          1,662   

Accrued postretirement health care costs

       1,562        797          2,359   

Due to Altria Group, Inc. and subsidiaries

         6,500        (6,500  

Other liabilities

     188        216        198          602   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer products liabilities

     20,116        7,150        15,264        (12,424     30,106   

Financial services

          

Deferred income taxes

         2,811          2,811   

Other liabilities

         330          330   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total financial services liabilities

         3,141          3,141   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

     20,116        7,150        18,405        (12,424     33,247   

Contingencies

          

Redeemable noncontrolling interest

         32          32   

Stockholders' Equity

          

Common stock

     935          9        (9     935   

Additional paid-in capital

     5,674        3,283        8,238        (11,521     5,674   

Earnings reinvested in the business

     23,583        210        265        (475     23,583   

Accumulated other comprehensive losses

     (1,887     (312     (1,649     1,961        (1,887

Cost of repurchased stock

     (24,625           (24,625
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stockholders' equity attributable to Altria Group, Inc.

     3,680        3,181        6,863        (10,044     3,680   

Noncontrolling interests

         3          3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stockholders' equity

     3,680        3,181        6,866        (10,044     3,683   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Liabilities and Stockholders’ Equity

   $ 23,796      $ 10,331      $ 25,303      $ (22,468   $ 36,962   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

-51-


Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Condensed Consolidating Statements of Earnings and Comprehensive Earnings

For the Three Months Ended March 31, 2012

(in millions of dollars)

 

     Altria
Group, Inc.
    PM
USA
    Non-
Guarantor
Subsidiaries
     Total
Consolidating
Adjustments
    Consolidated  

Net revenues

   $ —        $ 4,922      $ 731       $ (6   $ 5,647   

Cost of sales

       1,599        199         (6     1,792   

Excise taxes on products

       1,577        76           1,653   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Gross profit

       1,746        456           2,202   

Marketing, administration and research costs

     34        431        69           534   

Asset impairment and exit costs

       20        1           21   

Amortization of intangibles

         5           5   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Operating (expense) income

     (34     1,295        381           1,642   

Interest and other debt expense (income), net

     185        (1     109           293   

Earnings from equity investment in SABMiller

     (178            (178
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

(Loss) earnings before income taxes and equity earnings of subsidiaries

     (41     1,296        272           1,527   

(Benefit) provision for income taxes

     (36     482        108           554   

Equity earnings of subsidiaries

     978        49           (1,027  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net earnings attributable to Altria Group, Inc.

   $ 973      $ 863      $ 164       $ (1,027   $ 973   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive earnings attributable to Altria Group, Inc.

   $ 1,175      $ 862      $ 185       $ (1,047   $ 1,175   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

-52-


Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Condensed Consolidating Statements of Earnings and Comprehensive Earnings

For the Three Months Ended March 31, 2011

(in millions of dollars)

 

     Altria
Group, Inc.
    PM
USA
    Non-
Guarantor
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Net revenues

   $ —        $ 5,011      $ 638      $ (6   $ 5,643   

Cost of sales

       1,617        184        (6     1,795   

Excise taxes on products

       1,619        81          1,700   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

       1,775        373          2,148   

Marketing, administration and research costs

     45        498        58          601   

Asset impairment and exit costs

       2            2   

Amortization of intangibles

         6          6   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (expense) income

     (45     1,275        309          1,539   

Interest and other debt expense (income), net

     165        (2     115          278   

Earnings from equity investment in SABMiller

     (189           (189
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) earnings before income taxes and equity earnings of subsidiaries

     (21     1,277        194          1,450   

(Benefit) provision for income taxes

     (30     473        69          512   

Equity earnings of subsidiaries

     928        25          (953  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

     937        829        125        (953     938   

Net earnings attributable to noncontrolling interests

         (1       (1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings attributable to Altria Group, Inc.

   $ 937      $ 829      $ 124      $ (953   $ 937   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive earnings

   $ 1,030      $ 833      $ 151      $ (983   $ 1,031   

Comprehensive earnings attributable to noncontrolling interests

         (1       (1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive earnings attributable to Altria Group, Inc.

   $ 1,030      $ 833      $ 150      $ (983   $ 1,030   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Condensed Consolidating Statements of Cash Flows

For the Three Months Ended March 31, 2012

(in millions of dollars)

 

      Altria
Group, Inc.
    PM USA     Non-
Guarantor
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Cash Provided by (Used in) Operating Activities

          

Net cash (used in) provided by operating activities

   $ (390   $ 2,460      $ (233   $ —        $ 1,837   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash Provided by (Used in) Investing Activities

          

Consumer products

          

Capital expenditures

       (5     (11       (16

Financial services

          

Proceeds from finance assets

         303          303   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by investing activities

       (5     292          287   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash Provided by (Used in) Financing Activities

          

Repurchases of common stock

     (266           (266

Dividends paid on common stock

     (838           (838

Changes in amounts due to/from

          

Altria Group, Inc. and subsidiaries

     1,466        (1,549     83       

Cash dividends received from subsidiaries

     923        59          (982  

Cash dividends paid to parent

       (923     (59     982     

Other

       (42     (92       (134
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     1,285        (2,455     (68       (1,238
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents:

          

Increase (decrease)

     895        —          (9     —          886   

Balance at beginning of period

     3,245          25          3,270   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 4,140      $ —        $ 16      $ —        $ 4,156   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

-54-


Table of Contents

Altria Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Condensed Consolidating Statements of Cash Flows

For the Three Months Ended March 31, 2011

(in millions of dollars)

 

      Altria
Group, Inc.
    PM USA     Non-
Guarantor
Subsidiaries
    Total
Consolidating
Adjustments
    Consolidated  

Cash Provided by (Used in) Operating Activities

          

Net cash (used in) provided by operating activities

   $ (332   $ 2,514      $ (120   $ —        $ 2,062   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash Provided by (Used in) Investing Activities

          

Consumer products

          

Capital expenditures

       (4     (9       (13

Other

       1            1   

Financial services

          

Proceeds from finance assets

         4          4   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

       (3     (5       (8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash Provided by (Used in) Financing Activities

          

Dividends paid on common stock

     (794           (794

Issuances of common stock

     21              21   

Changes in amounts due to/from

          

Altria Group, Inc. and subsidiaries

     1,319        (1,540     221       

Cash dividends received from subsidiaries

     890        26          (916  

Cash dividends paid to parent

       (890     (26     916     

Other

     15        (107     (71       (163
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     1,451        (2,511     124          (936
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents:

          

Increase (decrease)

     1,119        —          (1     —          1,118   

Balance at beginning of period

     2,298          16          2,314   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 3,417      $ —        $ 15      $ —        $ 3,432   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

-55-


Table of Contents
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Description of the Company

At March 31, 2012, Altria Group, Inc.’s direct and indirect wholly-owned subsidiaries included Philip Morris USA Inc. (“PM USA”), which is engaged in the manufacture and sale of cigarettes and certain smokeless products in the United States; John Middleton Co. (“Middleton”), which is engaged in the manufacture and sale of machine-made large cigars and pipe tobacco, and is a wholly-owned subsidiary of PM USA; and UST LLC (“UST”), which through its direct and indirect wholly-owned subsidiaries including U.S. Smokeless Tobacco Company LLC (“USSTC”) and Ste. Michelle Wine Estates Ltd. (“Ste. Michelle”), is engaged in the manufacture and sale of smokeless products and wine. Philip Morris Capital Corporation (“PMCC”), another wholly-owned subsidiary of Altria Group, Inc., maintains a portfolio of leveraged and direct finance leases. In addition, Altria Group, Inc. held a 27.0% economic and voting interest in SABMiller plc (“SABMiller”) at March 31, 2012, which is accounted for under the equity method of accounting. Altria Group, Inc.’s access to the operating cash flows of its wholly-owned subsidiaries consists of cash received from the payment of dividends and distributions, and the payment of interest on intercompany loans by its subsidiaries. In addition, Altria Group, Inc. receives cash dividends on its interest in SABMiller, if and when SABMiller pays such dividends. At March 31, 2012, Altria Group, Inc.’s principal wholly-owned subsidiaries were not limited by long-term debt or other agreements in their ability to pay cash dividends or make other distributions with respect to their common stock.

Altria Group, Inc.’s chief operating decision maker has been evaluating the operating results of the former cigarettes and cigars segments as a single smokeable products segment since January 1, 2012. The combination of these two formerly separate segments is related to the restructuring associated with a cost reduction program announced in October 2011 (the “2011 Cost Reduction Program”). Also, in connection with the 2011 Cost Reduction Program, effective January 1, 2012, Middleton became a wholly-owned subsidiary of PM USA, reflecting management’s goal to achieve efficiencies in the management of these businesses. Effective with the first quarter of 2012, Altria Group, Inc.’s reportable segments are smokeable products, smokeless products, wine and financial services. As a result of the revised reportable segments and Middleton becoming a wholly-owned subsidiary of PM USA, certain prior-period amounts have been recast to conform with the current-period presentation. For further discussion on the 2011 Cost Reduction Program, see Note 2. Asset Impairment, Exit and Implementation Costs to the condensed consolidated financial statements (“Note 2”).

 

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Table of Contents

Executive Summary

The following executive summary is intended to provide significant highlights of the Discussion and Analysis that follows.

Consolidated Results of Operations for the Three Months Ended March 31, 2012 – The changes in Altria Group, Inc.’s net earnings and diluted earnings per share (“EPS”) attributable to Altria Group, Inc. for the three months ended March 31, 2012, from the three months ended March 31, 2011, were due primarily to the following:

 

     Net Earnings     Diluted EPS  
     (in millions, except per share data)  

For the three months ended March 31, 2011

   $ 937      $ 0.45   

2011 Asset impairment and exit costs

     1     

2011 UST acquisition-related costs

     3     

2011 SABMiller special items

     (21     (0.01
  

 

 

   

 

 

 

Subtotal 2011 items

     (17     (0.01
  

 

 

   

 

 

 

2012 Asset impairment, exit and implementation costs

     (3  

2012 SABMiller special items

     (25     (0.01
  

 

 

   

 

 

 

Subtotal 2012 items

     (28     (0.01
  

 

 

   

 

 

 

Fewer shares outstanding

       0.01   

Operations

     81        0.04   
  

 

 

   

 

 

 

For the three months ended March 31, 2012

   $ 973      $ 0.48   
  

 

 

   

 

 

 

See discussion of events affecting the comparability of statement of earnings amounts in the Consolidated Operating Results section of the following Discussion and Analysis.

Shares Outstanding: Fewer shares outstanding during the three months ended March 31, 2012