Exhibit 99.1

Altria Group, Inc.

and Subsidiaries

Consolidated Financial Statements as of

December 31, 2011 and 2010, and for Each of the

Three Years in the Period Ended December 31, 2011

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Altria Group, Inc. and Subsidiaries

Consolidated Balance Sheets

at December 31,

(in millions of dollars)

 

 

 

		2011				2010
Assets
Consumer products
Cash and cash equivalents		$	3,270			$	2,314
Receivables			268				85
Inventories:
Leaf tobacco			934				960
Other raw materials			170				160
Work in process			316				299
Finished product			359				384
			1,779				1,803
Deferred income taxes			1,207				1,165
Other current assets			607				614
Total current assets			7,131				5,981
Property, plant and equipment, at cost:
Land and land improvements			290				291
Buildings and building equipment			1,271				1,292
Machinery and equipment			3,097				3,473
Construction in progress			70				94
			4,728				5,150
Less accumulated depreciation			2,512				2,770
			2,216				2,380
Goodwill			5,174				5,174
Other intangible assets, net			12,098				12,118
Investment in SABMiller			5,509				5,367
Other assets			1,257				1,851
Total consumer products assets			33,385				32,871
Financial services
Finance assets, net			3,559				4,502
Other assets			18				29
Total financial services assets			3,577				4,531
Total Assets		$	36,962			$	37,402

See notes to consolidated financial statements.

 

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Altria Group, Inc. and Subsidiaries

Consolidated Balance Sheets (Continued)

at December 31,

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

 

 

 

		2011				2010
Liabilities
Consumer products
Current portion of long-term debt		$	600			$	—
Accounts payable			503				529
Accrued liabilities:
Marketing			430				447
Taxes, except income taxes			220				231
Employment costs			225				232
Settlement charges			3,513				3,535
Other			1,311				1,069
Dividends payable			841				797
Total current liabilities			7,643				6,840
Long-term debt			13,089				12,194
Deferred income taxes			4,751				4,618
Accrued pension costs			1,662				1,191
Accrued postretirement health care costs			2,359				2,402
Other liabilities			602				949
Total consumer products liabilities			30,106				28,194
Financial services
Deferred income taxes			2,811				3,880
Other liabilities			330				101
Total financial services liabilities			3,141				3,981
Total liabilities			33,247				32,175
Contingencies (Note 19)
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			5,674				5,751
Earnings reinvested in the business			23,583				23,459
Accumulated other comprehensive losses			(1,887	)			(1,484	)
Cost of repurchased stock (761,542,032 shares in 2011 and 717,221,651 shares in 2010)			(24,625	)			(23,469	)
Total stockholders’ equity attributable to Altria Group, Inc.			3,680				5,192
Noncontrolling interests			3				3
Total stockholders’ equity			3,683				5,195
Total Liabilities and Stockholders’ Equity		$	36,962			$	37,402

See notes to consolidated financial statements.

 

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Altria Group, Inc. and Subsidiaries

Consolidated Statements of Earnings

for the years ended December 31,

(in millions of dollars, except per share data)

 

 

 

		2011				2010				2009
Net revenues		$	23,800			$	24,363			$	23,556
Cost of sales			7,680				7,704				7,990
Excise taxes on products			7,181				7,471				6,732
Gross profit			8,939				9,188				8,834
Marketing, administration and research costs			2,643				2,735				2,843
Changes to Kraft and PMI tax-related receivables			(14	)			169				88
Asset impairment and exit costs			222				36				421
Amortization of intangibles			20				20				20
Operating income			6,068				6,228				5,462
Interest and other debt expense, net			1,216				1,133				1,185
Earnings from equity investment in SABMiller			(730	)			(628	)			(600	)
Earnings before income taxes			5,582				5,723				4,877
Provision for income taxes			2,189				1,816				1,669
Net earnings			3,393				3,907				3,208
Net earnings attributable to noncontrolling interests			(3	)			(2	)			(2	)
Net earnings attributable to Altria Group, Inc.		$	3,390			$	3,905			$	3,206
Per share data:
Basic earnings per share attributable to Altria Group, Inc.		$	1.64			$	1.87			$	1.55
Diluted earnings per share attributable to Altria Group, Inc.		$	1.64			$	1.87			$	1.54

See notes to consolidated financial statements.

 

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Altria Group, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(in millions of dollars, except per share data)

 

 

 

		Attributable to Altria Group, Inc.
		Common Stock				Additional Paid-in Capital				Earnings Reinvested in the Business				Accumulated Other Comprehensive Losses				Cost of Repurchased Stock				Comprehensive Earnings				Non- controlling Interests				Total Stockholders’ Equity
Balances, December 31, 2008		$	935			$	6,350			$	22,131			$	(2,181	)		$	(24,407	)		$	—			$	—			$	2,828
Comprehensive earnings:
Net earnings (a)											3,206												3,206				1				3,207
Other comprehensive earnings, net of deferred income taxes:
Currency translation adjustments															3								3								3
Changes in net loss and prior service cost															375								375								375
Ownership share of SABMiller’s other comprehensive earnings															242								242								242
Total other comprehensive earnings																							620				—				620
Total comprehensive earnings																							3,826				1				3,827
Exercise of stock options and other stock award activity							(353	)											506												153
Cash dividends declared ($1.32 per share)											(2,738	)																			(2,738	)
Other																											2				2
Balances, December 31, 2009			935				5,997				22,599				(1,561	)			(23,901	)							3				4,072
Comprehensive earnings:
Net earnings (a)											3,905												3,905				1				3,906
Other comprehensive earnings, net of deferred income taxes:
Currency translation adjustments															1								1								1
Changes in net loss and prior service cost															35								35								35
Ownership share of SABMiller’s other comprehensive earnings															41								41								41
Total other comprehensive earnings																							77				—				77
Total comprehensive earnings																							3,982				1				3,983
Exercise of stock options and other stock award activity							(246	)											432												186
Cash dividends declared ($1.46 per share)											(3,045	)																			(3,045	)
Other																											(1	)			(1	)
Balances, December 31, 2010			935				5,751				23,459				(1,484	)			(23,469	)							3				5,195
Comprehensive earnings:
Net earnings (a)											3,390												3,390				1				3,391
Other comprehensive earnings, net of deferred income taxes:
Currency translation adjustments															(2	)							(2	)							(2	)
Changes in net loss and prior service cost															(251	)							(251	)							(251	)
Ownership share of SABMiller’s other comprehensive losses															(150	)							(150	)							(150	)
Total other comprehensive losses																							(403	)			—				(403	)
Total comprehensive earnings																							2,987				1				2,988
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

 

(a)

Net earnings attributable to noncontrolling interests for the years ended December 31, 2011, 2010 and 2009 exclude $2 million, $1 million and $1 million, respectively, due to the redeemable noncontrolling interest related to Stag’s Leap Wine Cellars, which is reported in the mezzanine equity section in the consolidated balance sheets at December 31, 2011, 2010 and 2009, respectively. See Note 19.

See notes to consolidated financial statements.

 

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Altria Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

for the years ended December 31,

(in millions of dollars)

 

 

 

		2011				2010				2009
Cash Provided by (Used in) Operating Activities
Net earnings (loss)    - Consumer products		$	3,905			$	3,819			$	3,054
- Financial services			(512	)			88				154
Net earnings			3,393				3,907				3,208
Adjustments to reconcile net earnings to operating cash flows:
Consumer products
Depreciation and amortization			253				276				291
Deferred income tax provision			382				408				499
Earnings from equity investment in SABMiller			(730	)			(628	)			(600	)
Dividends from SABMiller			357				303				254
Asset impairment and exit costs, net of cash paid			179				(188	)			(22	)
IRS payment related to LILO and SILO transactions							(945	)
Cash effects of changes, net of the effects from acquisition of UST:
Receivables, net			(19	)			15				(7	)
Inventories			24				7				51
Accounts payable			(60	)			48				(25	)
Income taxes			(151	)			(53	)			130
Accrued liabilities and other current assets			21				(221	)			218
Accrued settlement charges			(22	)			(100	)			(346	)
Pension plan contributions			(240	)			(30	)			(37	)
Pension provisions and postretirement, net			243				185				193
Other			47				96				232
Financial services
Deferred income tax benefit			(825	)			(284	)			(456	)
PMCC Leveraged Lease Charge			490
Net increase to allowance for losses			25								15
Other			246				(29	)			(155	)
Net cash provided by operating activities			3,613				2,767				3,443

See notes to consolidated financial statements.

 

6

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Altria Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (Continued)

for the years ended December 31,

(in millions of dollars)

 

 

 

		2011				2010				2009
Cash Provided by (Used in) Investing Activities
Consumer products
Capital expenditures		$	(105	)		$	(168	)		$	(273	)
Acquisition of UST, net of acquired cash											(10,244	)
Other			2				115				(31	)
Financial services
Investments in finance assets											(9	)
Proceeds from finance assets			490				312				793
Net cash provided by (used in) investing activities			387				259				(9,764	)
Cash Provided by (Used in) Financing Activities
Consumer products
Net repayment of short-term borrowings											(205	)
Long-term debt issued			1,494				1,007				4,221
Long-term debt repaid							(775	)			(375	)
Financial services
Long-term debt repaid											(500	)
Repurchases of common stock			(1,327	)
Dividends paid on common stock			(3,222	)			(2,958	)			(2,693	)
Issuances of common stock			29				104				89
Financing fees and debt issuance costs			(24	)			(6	)			(177	)
Other			6				45				(84	)
Net cash (used in) provided by financing activities			(3,044	)			(2,583	)			276
Cash and cash equivalents:
Increase (Decrease)			956				443				(6,045	)
Balance at beginning of year			2,314				1,871				7,916
Balance at end of year		$	3,270			$	2,314			$	1,871
Cash paid:   - Interest      - Consumer products		$	1,154			$	1,084			$	904
- Financial services		$	—			$	—			$	38
- Income taxes		$	2,865			$	1,884			$	1,606

See notes to consolidated financial statements.

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Note 1. Background and Basis of Presentation:

Background: At December 31, 2011, Altria Group, Inc.’s 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; 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; and John Middleton Co. (“Middleton”), which is engaged in the manufacture and sale of machine-made large cigars and pipe tobacco. 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 December 31, 2011, 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 December 31, 2011, 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.

UST Acquisition: As discussed in Note 3. UST Acquisition, on January 6, 2009, Altria Group, Inc. acquired all of the outstanding common stock of UST. As a result of the acquisition, UST has become an indirect wholly-owned subsidiary of Altria Group, Inc.

Dividends and Share Repurchases: In August 2011, Altria Group, Inc.’s Board of Directors approved a 7.9% increase in the quarterly dividend rate to $0.41 per common share versus the previous rate of $0.38 per common share. The current annualized dividend rate is $1.64 per Altria Group, Inc. common share. Future dividend payments remain subject to the discretion of Altria Group, Inc.’s Board of Directors.

In January 2011, Altria Group, Inc.’s Board of Directors authorized a $1.0 billion one-year share repurchase program. Altria Group, Inc. completed this share repurchase program during the third quarter of 2011. Under this program, Altria Group, Inc. repurchased a total of 37.6 million shares of its common stock at an average price of $26.62 per share.

In October 2011, Altria Group, Inc.’s Board of Directors authorized a new $1.0 billion share repurchase program, which Altria Group, Inc. intends to complete by the end of 2012. During the fourth quarter of 2011, Altria Group, Inc. repurchased 11.7 million shares of its common stock at an aggregate cost of approximately $327 million, and an average price of $27.84 per share, under this share repurchase program. Share repurchases under the new program will depend upon marketplace conditions and other factors, and the program remains subject to the discretion of Altria Group, Inc.’s Board of Directors.

During 2011, Altria Group, Inc. repurchased a total of 49.3 million shares of its common stock under the two programs at an aggregate cost of approximately $1.3 billion, and an average price of $26.91 per share.

Basis of presentation: The consolidated financial statements include Altria Group, Inc., as well as its wholly-owned and majority-owned subsidiaries. Investments in which Altria Group, Inc. exercises significant influence are accounted for under the equity method of accounting. All intercompany transactions and balances have been eliminated.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the dates of the financial statements and the reported amounts of net revenues and expenses during the reporting periods. Significant estimates and assumptions include, among other things, pension and benefit plan assumptions, lives and valuation assumptions for goodwill and other intangible assets, marketing programs, income taxes, and the allowance for loan losses and estimated residual values of finance leases. Actual results could differ from those estimates.

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Balance sheet accounts are segregated by two broad types of business. 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.

Note 2. Summary of Significant Accounting Policies:

Cash and cash equivalents: Cash equivalents include demand deposits with banks and all highly liquid investments with original maturities of three months or less. Cash equivalents are stated at cost plus accrued interest, which approximates fair value.

Depreciation, amortization, impairment testing and asset valuation: Property, plant and equipment are stated at historical costs and depreciated by the straight-line method over the estimated useful lives of the assets. Machinery and equipment are depreciated over periods up to 25 years, and buildings and building improvements over periods up to 50 years. Definite-lived intangible assets are amortized over their estimated useful lives up to 25 years.

Altria Group, Inc. reviews long-lived assets, including definite-lived intangible assets, for impairment whenever events or changes in business circumstances indicate that the carrying value of the assets may not be fully recoverable. Altria Group, Inc. performs undiscounted operating cash flow analyses to determine if an impairment exists. For purposes of recognition and measurement of an impairment for assets held for use, Altria Group, Inc. groups assets and liabilities at the lowest level for which cash flows are separately identifiable. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal.

Altria Group, Inc. conducts a required annual review of goodwill and indefinite-lived intangible assets for potential impairment, and more frequently if an event occurs or circumstances change that would require Altria Group, Inc. to perform an interim review. Goodwill impairment testing requires a comparison between the carrying value and fair value of each reporting unit. If the carrying value exceeds the fair value, goodwill is considered impaired. The amount of impairment loss is measured as the difference between the carrying value and implied fair value of goodwill, which is determined using discounted cash flows. Impairment testing for indefinite-lived intangible assets requires a comparison between the fair value and carrying value of the intangible asset. If the carrying value exceeds fair value, the intangible asset is considered impaired and is reduced to fair value. During 2011, 2010 and 2009, Altria Group, Inc. completed its annual review of goodwill and indefinite-lived intangible assets, and no impairment charges resulted from these reviews.

Environmental costs: Altria Group, Inc. is subject to laws and regulations relating to the protection of the environment. 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.

Compliance with environmental laws and regulations, including the payment of any remediation and compliance 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 financial position, results of operations or cash flows (see Note 19. Contingencies – Environmental Regulation).

Fair value measurements: Altria Group, Inc. measures certain assets and liabilities at fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Altria Group, Inc. uses a fair value hierarchy, which gives the highest priority to unadjusted quoted prices in active markets for identical assets and liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of inputs used to measure fair value are:

 

Level 1		Unadjusted quoted prices in active markets for identical assets or liabilities.

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Level 2		Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3		Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The fair value of substantially all of Altria Group, Inc.’s pension assets is based on observable inputs, including readily available quoted market prices, which meet the definition of a Level 1 or Level 2 input. For the fair value disclosure of the pension plan assets, see Note 17. Benefit Plans.

Finance leases: Income attributable to leveraged leases is initially recorded as unearned income and subsequently recognized as revenue over the terms of the respective leases at constant after-tax rates of return on the positive net investment balances. Investments in leveraged leases are stated net of related nonrecourse debt obligations.

Income attributable to direct finance leases is initially recorded as unearned income and subsequently recognized as revenue over the terms of the respective leases at constant pre-tax rates of return on the net investment balances.

Finance leases include unguaranteed residual values that represent PMCC’s estimates at lease inception as to the fair values of assets under lease at the end of the non-cancelable lease terms. The estimated residual values are reviewed annually by PMCC’s management. This review includes analysis of a number of factors, including activity in the relevant industry. If necessary, revisions are recorded to reduce the residual values. Such reviews resulted in a decrease of $11 million to PMCC’s net revenues and results of operations in 2010. There were no adjustments in 2011 and 2009.

PMCC considers rents receivable past due when they are beyond the grace period of their contractual due date. PMCC stops recording income (“non-accrual status”) on rents receivable when contractual payments become 90 days past due or earlier if management believes there is significant uncertainty of collectability of rent payments, and resumes recording income when collectability of rent payments is reasonably certain. Payments received on rents receivable that are on non-accrual status are used to reduce the rents receivable balance. Write-offs to the allowance for losses are recorded when amounts are deemed to be uncollectible.

Guarantees: Altria Group, Inc. recognizes a liability for the fair value of the obligation of qualifying guarantee activities. See Note 19. Contingencies for a further discussion of guarantees.

Income taxes: Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Significant judgment is required in determining income tax provisions and in evaluating tax positions.

Altria Group, Inc. recognizes a benefit for uncertain tax positions when a tax position taken or expected to be taken in a tax return is more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement.

Altria Group, Inc. recognizes accrued interest and penalties associated with uncertain tax positions as part of the provision for income taxes on its consolidated statements of earnings.

Inventories: Inventories are stated at the lower of cost or market. The last-in, first-out (“LIFO”) method is used to cost substantially all tobacco inventories. The cost of the remaining inventories is determined using the first-in, first-out and average cost methods. It is a generally recognized industry practice to classify leaf tobacco and wine

 

10

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

inventories as current assets although part of such inventory, because of the duration of the curing and aging process, ordinarily would not be utilized within one year.

Litigation contingencies and costs: Altria Group, Inc. and its subsidiaries record provisions in the consolidated financial statements for pending litigation when it is determined that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. Litigation defense costs are expensed as incurred and included in marketing, administration and research costs on the consolidated statements of earnings.

Marketing costs: The consumer products businesses promote their products with consumer engagement programs, consumer incentives and trade promotions. Such programs include, but are not limited to, discounts, coupons, rebates, in-store display incentives, event marketing and volume-based incentives. Consumer engagement programs are expensed as incurred. Consumer incentive and trade promotion activities are recorded as a reduction of revenues based on amounts estimated as being due to customers and consumers at the end of a period, based principally on historical utilization and redemption rates. For interim reporting purposes, consumer engagement programs and certain consumer incentive expenses are charged to operations as a percentage of sales, based on estimated sales and related expenses for the full year.

Revenue recognition: The consumer products businesses recognize revenues, net of sales incentives and sales returns, and including shipping and handling charges billed to customers, upon shipment or delivery of goods when title and risk of loss pass to customers. Payments received in advance of revenue recognition are deferred and recorded in other accrued liabilities until revenue is recognized. Altria Group, Inc.’s consumer products businesses also include excise taxes billed to customers in net revenues. Shipping and handling costs are classified as part of cost of sales.

Stock-based compensation: Altria Group, Inc. measures compensation cost for all stock-based awards at fair value on date of grant and recognizes compensation expense over the service periods for awards expected to vest. The fair value of restricted stock and deferred stock is determined based on the number of shares granted and the market value at date of grant.

New accounting standards: In September 2011, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance to simplify how entities test goodwill for impairment. The guidance permits an entity to first assess qualitative factors to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The new guidance is effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011; however, early adoption is permitted. Altria Group, Inc. performed a quantitative impairment test for its 2011 annual review of goodwill under the existing guidance and will evaluate performing a qualitative assessment in 2012.

In June and December 2011, the FASB issued authoritative guidance that will eliminate the option of presenting components of other comprehensive earnings as part of the statement of stockholders’ equity. The guidance will instead require the reporting of other comprehensive earnings in a single continuous statement of comprehensive earnings or in a separate statement immediately following the statement of earnings. The new guidance is effective for interim and annual reporting periods beginning after December 15, 2011; however, early adoption is permitted. Altria Group, Inc. intends to comply with the new reporting requirements beginning in the first quarter of 2012.

In May 2011, the FASB issued authoritative guidance relating to fair value measurement and disclosure requirements. The new guidance is effective for interim and annual periods beginning after December 15, 2011. Early adoption is not permitted. The adoption of this guidance will not have a significant impact on Altria Group, Inc.’s existing fair value measurements or disclosures.

Note 3. UST Acquisition:

On January 6, 2009, Altria Group, Inc. acquired all of the outstanding common stock of UST. The transaction was valued at approximately $11.7 billion, which represented a purchase price of $10.4 billion and approximately $1.3 billion of UST debt, which together with acquisition-related costs and payments of approximately $0.6 billion

 

11

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

(consisting primarily of financing fees, the funding of UST’s non-qualified pension plans, investment banking fees and the early retirement of UST’s revolving credit facility), represented a total cash outlay of approximately $11 billion.

In connection with the acquisition of UST, Altria Group, Inc. had in place at December 31, 2008, a 364-day term bridge loan facility (“Bridge Facility”). On January 6, 2009, Altria Group, Inc. borrowed the entire available amount of $4.3 billion under the Bridge Facility, which was used along with available cash of $6.7 billion, representing the net proceeds from the issuances of senior unsecured long-term notes in November and December 2008, to fund the acquisition of UST. In February 2009, Altria Group, Inc. also issued $4.2 billion of senior unsecured long-term notes. The net proceeds from the issuance of these notes, along with available cash, were used to prepay all of the outstanding borrowings under the Bridge Facility. Upon such prepayment, the Bridge Facility was terminated.

UST’s financial position and results of operations have been consolidated with Altria Group, Inc. as of January 6, 2009. Pro forma results of Altria Group, Inc., for the year ended December 31, 2009, assuming the acquisition had occurred on January 1, 2009, would not be materially different from the actual results reported for the year ended December 31, 2009.

During the fourth quarter of 2009, the allocation of purchase price relating to the acquisition of UST was completed. The following amounts represent the fair value of identifiable assets acquired and liabilities assumed in the UST acquisition:

 

(in millions)
Cash and cash equivalents		$	163
Inventories			796
Property, plant and equipment			688
Other intangible assets:
Indefinite-lived trademarks			9,059
Definite-lived (20-year life)			60
Short-term borrowings			(205	)
Current portion of long-term debt			(240	)
Long-term debt			(900	)
Deferred income taxes			(3,535	)
Other assets and liabilities, net			(540	)
Noncontrolling interests			(36	)
Total identifiable net assets			5,310
Total purchase price			10,407
Goodwill		$	5,097

The excess of the purchase price paid by Altria Group, Inc. over the fair value of identifiable net assets acquired in the acquisition of UST primarily reflects the value of adding USSTC and its subsidiaries to Altria Group, Inc.’s family of tobacco operating companies (PM USA and Middleton), with leading brands in cigarettes, smokeless products and machine-made large cigars, and anticipated annual synergies of approximately $300 million resulting primarily from reduced selling, general and administrative, and corporate expenses. None of the goodwill or other intangible assets will be deductible for tax purposes.

The assets acquired, liabilities assumed and noncontrolling interests of UST have been measured as of the acquisition date. In valuing trademarks, Altria Group, Inc. estimated the fair value using a discounted cash flow methodology. No material contingent liabilities were recognized as of the acquisition date because the acquisition date fair value of such contingencies cannot be determined, and the contingencies are not both probable and reasonably estimable. Additionally, costs incurred to effect the acquisition, as well as costs to restructure UST, are being recognized as expenses in the periods in which the costs are incurred. For the years ended December 31, 2011, 2010 and 2009, Altria Group, Inc. incurred pre-tax acquisition-related charges, as well as restructuring and integration costs, consisting of the following:

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

		For the Years Ended December 31,
(in millions)		2011				2010				2009
Asset impairment and exit costs		$	(4	)		$	6			$	202
Integration costs			3				18				49
Inventory adjustments			6				22				36
Financing fees											91
Transaction costs											60
Total		$	5			$	46			$	438

Total acquisition-related charges, as well as restructuring and integration costs incurred since the September 8, 2008 announcement of the acquisition, were $547 million as of December 31, 2011. As of December 31, 2011, pre-tax charges and costs related to the acquisition of UST have been completed.

Note 4. Goodwill and Other Intangible Assets, net:

Goodwill and other intangible assets, net, by segment were as follows:

 

		Goodwill								Other Intangible Assets, net
(in millions)		December 31, 2011				December 31, 2010				December 31, 2011				December 31, 2010
Cigarettes		$	—			$	—			$	250			$	261
Smokeless products			5,023				5,023				8,841				8,843
Cigars			77				77				2,738				2,744
Wine			74				74				269				270
Total		$	5,174			$	5,174			$	12,098			$	12,118

Goodwill relates to the January 2009 acquisition of UST (see Note 3. UST Acquisition) and the December 2007 acquisition of Middleton.

Other intangible assets consisted of the following:

 

		December 31, 2011								December 31, 2010
(in millions)		Gross Carrying Amount				Accumulated Amortization				Gross Carrying Amount				Accumulated Amortization
Indefinite-lived intangible assets		$	11,701							$	11,701
Definite-lived intangible assets			464			$	67				464			$	47
Total other intangible assets		$	12,165			$	67			$	12,165			$	47

Indefinite-lived intangible assets consist substantially of trademarks from the January 2009 acquisition of UST ($9.1 billion) and the December 2007 acquisition of Middleton ($2.6 billion). Definite-lived intangible assets, which consist primarily of customer relationships and certain cigarette trademarks, are amortized over periods up to 25 years. Pre-tax amortization expense for definite-lived intangible assets during each of the years ended December 31, 2011, 2010 and 2009, was $20 million. Annual amortization expense for each of the next five years is estimated to be approximately $20 million, assuming no additional transactions occur that require the amortization of intangible assets.

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

There were no changes in goodwill and the gross carrying amount of other intangible assets for the years ended December 31, 2011 and 2010.

Note 5. Asset Impairment, Exit, Implementation and Integration Costs:

Pre-tax asset impairment, exit, implementation and integration costs for the years ended December 31, 2011, 2010 and 2009 consisted of the following:

 

		For the Year Ended December 31, 2011
(in millions)		Asset Impairment and Exit Costs				Implementation Costs				Integration Costs				Total
Cigarettes		$	178			$	1			$	—			$	179
Smokeless products			32								3				35
Cigars			4												4
General corporate			8												8
Total		$	222			$	1			$	3			$	226
		For the Year Ended December 31, 2010
(in millions)		Asset Impairment and Exit Costs				Implementation Costs				Integration Costs				Total
Cigarettes		$	24			$	75			$	—			$	99
Smokeless products			6								16				22
Cigars											2				2
Wine											2				2
General corporate			6												6
Total		$	36			$	75			$	20			$	131
		For the Year Ended December 31, 2009
(in millions)		Asset Impairment and Exit Costs				Implementation Costs				Integration Costs				Total
Cigarettes		$	115			$	139			$	—			$	254
Smokeless products			193								43				236
Cigars											9				9
Wine			3								6				9
Financial services			19												19
General corporate			91												91
Total		$	421			$	139			$	58			$	618

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

The movement in the severance liability and details of asset impairment and exit costs for Altria Group, Inc. for the years ended December 31, 2011 and 2010 was as follows:

 

(in millions)		Severance				Other				Total
Severance liability balance, December 31, 2009		$	228			$	—			$	228
Charges, net			(11	)			47				36
Cash spent			(191	)			(36	)			(227	)
Other							(11	)			(11	)
Severance liability balance, December 31, 2010			26				—				26
Charges, net			154				68				222
Cash spent			(24	)			(20	)			(44	)
Other							(48	)			(48	)
Severance liability balance, December 31, 2011		$	156			$	—			$	156

Other charges in the table above primarily include other employee termination benefits, including pension and postretirement, and asset impairments. Charges, net in the table above include the reversal in 2011 of lease exit costs ($4 million) associated with the UST integration, and the reversal in 2010 of severance costs ($13 million) associated with the Manufacturing Optimization Program.

The pre-tax asset impairment, exit, implementation, and integration costs shown above are primarily a result of the programs discussed below.

2011 Cost Reduction Program: In October 2011, Altria Group, Inc. announced a new cost reduction program (the “2011 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 cigarette volume declines. As a result of this program, Altria Group, Inc. expects to incur total pre-tax charges of approximately $300 million (concluding in 2012), which is lower than the original estimate of $375 million due primarily to lower-than-expected employee separation costs. The estimated charges include employee separation costs of approximately $220 million and other charges of approximately $80 million, which include lease termination and asset impairments. Substantially all of these charges will result in cash expenditures.

For the year ended December 31, 2011, total pre-tax asset impairment and exit costs of $223 million were recorded for this program in the cigarettes segment ($175 million), smokeless products segment ($36 million), cigars segment ($4 million) and general corporate ($8 million). In addition, pre-tax implementation costs of $1 million were recorded in the cigarettes segment for total pre-tax charges of $224 million related to this program. The pre-tax implementation costs were included in marketing, administration and research costs on Altria Group, Inc.’s consolidated statement of earnings for the year ended December 31, 2011. Cash payments related to this program of $9 million were made during the year ended December 31, 2011.

In connection with the 2011 Cost Reduction Program, Altria Group, Inc. has reorganized its tobacco operating companies and, effective January 1, 2012, Middleton became a wholly-owned subsidiary of PM USA. In addition, beginning in 2012, Altria Group, Inc. has revised its reportable segments (see Note 16. Segment Reporting).

Integration and Restructuring Program: Altria Group, Inc. has completed a restructuring program that commenced in December 2008, and was expanded in August 2009. Pursuant to this program, Altria Group, Inc. restructured corporate, manufacturing, and sales and marketing services functions in connection with the integration of UST and its focus on optimizing company-wide cost structures in light of ongoing declines in U.S. cigarette volumes.

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

As part of this program, Altria Group, Inc. recorded a reversal of $4 million for pre-tax asset impairment and exit costs, and a pre-tax charge of $3 million for integration costs in the smokeless products segment for the year ended December 31, 2011. Pre-tax asset impairment, exit and integration costs for the years ended December 31, 2010 and 2009 consisted of the following:

 

		For the Year Ended December 31, 2010
(in millions)		Asset Impairment and Exit Costs				Integration Costs				Total
Smokeless products		$	6			$	16			$	22
Wine							2				2
General corporate			4								4
Total		$	10			$	18			$	28
		For the Year Ended December 31, 2009
(in millions)		Asset Impairment and Exit Costs				Integration Costs				Total
Cigarettes		$	18			$	—			$	18
Smokeless products			193				43				236
Wine			3				6				9
Financial services			4								4
General corporate			61								61
Total		$	279			$	49			$	328

These charges are primarily related to employee separation costs, lease exit costs, relocation of employees, asset impairment and other costs related to the integration of UST operations. The pre-tax integration costs were included in marketing, administration and research costs on Altria Group, Inc.’s consolidated statements of earnings for the years ended December 31, 2011, 2010 and 2009. Total pre-tax charges incurred since the inception of the program through December 31, 2011 were $481 million. Cash payments related to the program of $20 million, $111 million and $221 million were made during the years ended December 31, 2011, 2010 and 2009, respectively, for a total of $352 million since inception. Cash payments related to this program have been completed.

Manufacturing Optimization Program: PM USA ceased production at its Cabarrus, North Carolina manufacturing facility and completed the consolidation of its cigarette manufacturing capacity into its Richmond, Virginia facility on July 29, 2009. PM USA took this action to address ongoing cigarette volume declines including the impact of the federal excise tax increase enacted in early 2009. In April 2011, PM USA completed the de-commissioning of the Cabarrus facility.

PM USA continues to market for sale the Cabarrus facility and land. The future sale of the Cabarrus facility and land is not expected to have a material impact on the financial results of Altria Group, Inc.

As a result of this program, which commenced in 2007, PM USA expects to incur total pre-tax charges of approximately $800 million, which consist of employee separation costs of $325 million, accelerated depreciation of $275 million and other charges of $200 million, primarily related to the relocation of employees and equipment, net of estimated gains on sales of land and buildings. Total pre-tax charges incurred for the program through December 31, 2011 of $827 million, which are reflected in the cigarettes segment, do not reflect estimated gains from the future sales of land and buildings.

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

PM USA recorded pre-tax charges for this program as follows:

 

		For the Years Ended December 31,
(in millions)		2011				2010				2009
Asset impairment and exit costs		$	3			$	24			$	97
Implementation costs							75				139
Total		$	3			$	99			$	236

Pre-tax implementation costs related to this program were primarily related to accelerated depreciation and were included in cost of sales in the consolidated statements of earnings for the years ended December 31, 2010 and 2009, respectively.

Cash payments related to the program of $16 million, $128 million and $210 million were made during the years ended December 31, 2011, 2010 and 2009, respectively, for total cash payments of $450 million since inception. Cash payments related to this program have been completed.

Note 6. Inventories:

The cost of approximately 70% and 71% of inventories in 2011 and 2010, respectively, was determined using the LIFO method. The stated LIFO amounts of inventories were approximately $0.6 billion and $0.7 billion lower than the current cost of inventories at December 31, 2011 and 2010, respectively.

Note 7. Investment in SABMiller:

At December 31, 2011, Altria Group, Inc. held a 27.0% economic and voting interest in SABMiller. Altria Group, Inc.’s investment in SABMiller is being accounted for under the equity method.

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

 

		For the Years Ended December 31,
(in millions)		2011				2010				2009
Equity earnings		$	703			$	578			$	407
Gains resulting from issuances of common stock by SABMiller			27				50				193
		$	730			$	628			$	600

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Summary financial data of SABMiller is as follows:

 

		At December 31,
(in millions)		2011				2010
Current assets		$	5,967			$	4,518
Long-term assets		$	46,438			$	34,744
Current liabilities		$	7,591			$	6,625
Long-term liabilities		$	22,521			$	11,270
Non-controlling interests		$	1,013			$	766

 

		For the Years Ended December 31,
(in millions)		2011				2010				2009
Net revenues		$	20,780			$	18,981			$	17,020
Operating profit		$	3,603			$	2,821			$	2,173
Net earnings		$	2,596			$	2,133			$	1,473

The fair value, based on unadjusted quoted prices in active markets, of Altria Group, Inc.’s equity investment in SABMiller at December 31, 2011, was $15.2 billion, as compared with its carrying value of $5.5 billion. The fair value, based on unadjusted quoted prices in active markets, of Altria Group, Inc.’s equity investment in SABMiller at December 31, 2010, was $15.1 billion, as compared with its carrying value of $5.4 billion.

Note 8. Finance Assets, net:

In 2003, PMCC ceased making new investments and began focusing exclusively on managing its existing portfolio of finance assets in order to maximize gains and generate cash flow from asset sales and related activities. Accordingly, PMCC’s operating companies income will fluctuate over time as investments mature or are sold. During 2011, 2010 and 2009, proceeds from asset management activities totaled $490 million, $312 million and $793 million, respectively, and gains included in operating companies income totaled $107 million, $72 million and $257 million, respectively.

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. At December 31, 2010, finance assets, net, of $4,502 million were comprised of investments in finance leases of $4,704 million, reduced by the allowance for losses of $202 million.

During the second quarter of 2011, Altria Group, Inc. recorded a one-time charge of $627 million related to the tax treatment of certain leveraged lease transactions entered into by PMCC (the “PMCC Leveraged Lease Charge”). Approximately 50% of the charge ($315 million), which does not include potential penalties, represents a reduction in cumulative lease earnings recorded to date that will be recaptured over the remainder of the affected lease terms. The remaining portion of the charge ($312 million) primarily represents a permanent charge for interest on tax underpayments. The one-time charge was recorded in Altria Group, Inc.’s consolidated statement of earnings for the year ended December 31, 2011 as follows:

 

(in millions)		Net Revenues				Provision for Income Taxes				Total
Reduction to cumulative lease earnings		$	490			$	(175	)		$	315
Interest on tax underpayments							312				312
Total		$	490			$	137			$	627

 

18

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

See Note 15. Income Taxes and Note 19. Contingencies for further discussion of matters related to this charge.

A summary of the net investments in finance leases at December 31, before allowance for losses, was as follows:

 

		Leveraged Leases								Direct Finance Leases								Total
(in millions)		2011				2010				2011				2010				2011				2010
Rents receivable, net		$	3,926			$	4,659			$	162			$	207			$	4,088			$	4,866
Unguaranteed residual values			1,306				1,327				86				87				1,392				1,414
Unearned income			(1,692	)			(1,573	)			(2	)			(3	)			(1,694	)			(1,576	)
Investments in finance leases			3,540				4,413				246				291				3,786				4,704
Deferred income taxes			(2,793	)			(3,830	)			(107	)			(130	)			(2,900	)			(3,960	)
Net investments in finance leases		$	747			$	583			$	139			$	161			$	886			$	744

For leveraged leases, rents receivable, net, represent unpaid rents, net of principal and interest payments on third-party nonrecourse debt. PMCC’s rights to rents receivable are subordinate to the third-party nonrecourse debtholders, and the leased equipment is pledged as collateral to the debtholders. The repayment of the nonrecourse debt is collateralized by lease payments receivable and the leased property, and is nonrecourse to the general assets of PMCC. As required by U.S. GAAP, the third-party nonrecourse debt of $6.8 billion and $8.3 billion at December 31, 2011 and 2010, respectively, has been offset against the related rents receivable. There were no leases with contingent rentals in 2011 and 2010.

At December 31, 2011, PMCC’s investments in finance leases were principally comprised of the following investment categories: aircraft (30%), rail and surface transport (26%), electric power (25%), real estate (10%) and manufacturing (9%). Investments located outside the United States, which are all U.S. dollar-denominated, represented 13% and 23% of PMCC’s investments in finance leases at December 31, 2011 and 2010, respectively.

Rents receivable in excess of debt service requirements on third-party nonrecourse debt related to leveraged leases and rents receivable from direct finance leases at December 31, 2011 were as follows:

 

(in millions)		Leveraged Leases				Direct Finance Leases				Total
2012		$	108			$	45			$	153
2013			158				45				203
2014			243				45				288
2015			335								335
2016			149								149
Thereafter			2,933				27				2,960
Total		$	3,926			$	162			$	4,088

Included in net revenues for the years ended December 31, 2011, 2010 and 2009, were leveraged lease revenues of $(314) million, which includes a reduction to cumulative lease earnings of $490 million as a result of the PMCC Leveraged Lease Charge, $160 million and $341 million, respectively, and direct finance lease revenues of $1 million, $1 million and $7 million, respectively. Income tax (benefit) expense, excluding interest on tax underpayments, on leveraged lease revenues for the years ended December 31, 2011, 2010 and 2009, was $(112) million, $58 million and $119 million, respectively.

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Income from investment tax credits on leveraged leases, and initial direct and executory costs on direct finance leases, were not significant during the years ended December 31, 2011, 2010 and 2009.

PMCC maintains an allowance for losses, which provides for estimated losses on its investments in finance leases. PMCC’s portfolio consists of leveraged and direct finance leases to a diverse base of lessees participating in a wide variety of industries. Losses on such leases are recorded when probable and estimable. PMCC regularly performs a systematic assessment of each individual lease in its portfolio to determine potential credit or collection issues that might indicate impairment. Impairment takes into consideration both the probability of default and the likelihood of recovery if default were to occur. PMCC considers both quantitative and qualitative factors of each investment when performing its assessment of the allowance for losses.

Quantitative factors that indicate potential default are tied most directly to public debt ratings. PMCC monitors all publicly available information on its obligors, including financial statements and credit rating agency reports. Qualitative factors that indicate the likelihood of recovery if default were to occur include, but are not limited to, underlying collateral value, other forms of credit support, and legal/structural considerations impacting each lease. Using all available information, PMCC calculates potential losses for each lease in its portfolio based on its default and recovery assumption for each lease. The aggregate of these potential losses forms a range of potential losses which is used as a guideline to determine the adequacy of PMCC’s allowance for losses.

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 December 31, 2011, the allowance for losses of $227 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 years ended December 31, 2011, 2010 and 2009 was as follows:

 

(in millions)		2011				2010				2009
Balance at beginning of year		$	202			$	266			$	304
Increase to allowance			25								15
Amounts written-off							(64	)			(53	)
Balance at end of year		$	227			$	202			$	266

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. The 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. After assessing its allowance for losses, including the impact of the American bankruptcy filing, PMCC increased the allowance for losses by $60 million during the fourth quarter of 2011. With the exception of American, all PMCC lessees were current on their lease payment obligations as of December 31, 2011.

During the third quarter of 2011, PMCC determined that its allowance for losses exceeded the amount required based on its assessment of the credit quality of the leasing portfolio at that time including reductions in exposure to below investment grade lessees. As a result, the allowance for losses was reduced by $35 million.

PMCC leased, under several lease arrangements, various types of automotive manufacturing equipment to General Motors Corporation (“GM”), which filed for bankruptcy on June 1, 2009. As of the date of the bankruptcy filing, PMCC stopped recording income on its $214 million investment in finance leases from GM. During 2009, GM rejected one of the leases, which resulted in a $49 million write-off against PMCC’s allowance for losses, lowering the investment in finance leases balance from GM to $165 million. General Motors LLC (“New GM”), which is the successor of GM’s North American automobile business, agreed to assume nearly all the remaining leases under same terms as GM, except for a rebate of a portion of future rents. The assignment of the leases to New GM was approved by the bankruptcy court and became effective in March 2010. During the first quarter of 2010, GM

 

20

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

rejected another lease that was not assigned to New GM. The impact of the rent rebates and the 2010 lease rejection resulted in a $64 million write-off against PMCC’s allowance for losses in the first quarter of 2010. In the first quarter of 2010, PMCC participated in a transaction pursuant to which the equipment related to the rejected leases was sold to New GM. These transactions resulted in an acceleration of deferred taxes of $34 million in 2010. As of December 31, 2011 and 2010, PMCC’s investment in finance leases from New GM was $101 million.

During 2009, PMCC increased its allowance for losses by $15 million based on management’s assessment of its portfolio, including its exposure to GM.

The credit quality of PMCC’s investments in finance leases as assigned by Standard & Poor’s Rating Services (“Standard & Poor’s”) and Moody’s Investor Service, Inc. (“Moody’s”) at December 31, 2011 and 2010 was as follows:

 

(in millions)		2011				2010
Credit Rating by Standard & Poor’s/Moody’s:
“AAA/Aaa” to “A-/A3”		$	1,570			$	2,343
“BBB+/Baa1” to “BBB-/Baa3”			1,080				1,148
“BB+/Ba1” and Lower			1,136				1,213
Total		$	3,786			$	4,704

Note 9. Short-Term Borrowings and Borrowing Arrangements:

At December 31, 2011 and December 31, 2010, Altria Group, Inc. had no short-term borrowings. The credit line available to Altria Group, Inc. at December 31, 2011 was $3.0 billion.

On June 30, 2011, Altria Group, Inc. entered into a senior unsecured 5-year revolving credit agreement (the “Credit Agreement”). The Credit Agreement provides for borrowings up to an aggregate principal amount of $3.0 billion and expires on June 30, 2016. The Credit Agreement replaced Altria Group, Inc.’s $0.6 billion senior unsecured 364-day revolving credit agreement, which was to expire on November 16, 2011 (the “364-Day Agreement”), and Altria Group, Inc.’s $2.4 billion senior unsecured 3-year revolving credit agreement, which was to expire on November 20, 2012 (together with the 364-Day Agreement, the “Terminated Agreements”). The Terminated Agreements were terminated effective June 30, 2011. Pricing for interest and fees under the Credit Agreement may be modified in the event of a change in the rating of Altria Group, Inc.’s long-term senior unsecured debt. Interest rates on borrowings under the Credit Agreement are expected to be based on the London Interbank Offered Rate (“LIBOR”) plus a percentage equal to Altria Group, Inc.’s credit default swap spread subject to certain minimum rates and maximum rates based on the higher of the rating of Altria Group, Inc.’s long-term senior unsecured debt from Standard & Poor’s and Moody’s. The applicable minimum and maximum rates based on Altria Group, Inc.’s long-term senior unsecured debt ratings at December 31, 2011 for borrowings under the Credit Agreement are 0.75% and 1.75%, respectively. The Credit Agreement does not include any other rating triggers, nor does it contain any provisions that could require the posting of collateral.

The Credit Agreement is used for general corporate purposes and to support Altria Group, Inc.’s commercial paper issuances. As in the Terminated Agreements, the Credit Agreement requires that Altria Group, Inc. maintain (i) a ratio of debt to consolidated EBITDA of not more than 3.0 to 1.0 and (ii) a ratio of consolidated EBITDA to consolidated interest expense of not less than 4.0 to 1.0, each calculated as of the end of the applicable quarter on a rolling four quarters basis. At December 31, 2011, the ratios of debt to consolidated EBITDA and consolidated EBITDA to consolidated interest expense, calculated in accordance with the Credit Agreement, were 1.9 to 1.0 and 6.4 to 1.0, respectively. Altria Group, Inc. expects to continue to meet its covenants associated with the Credit Agreement. The terms “consolidated EBITDA,” “debt” and “consolidated interest expense,” as defined in the Credit Agreement, include certain adjustments.

Any commercial paper issued by Altria Group, Inc. and borrowings under the Credit Agreement are guaranteed by PM USA (see Note 20. Condensed Consolidating Financial Information).

 

21

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Note 10. Long-Term Debt:

At December 31, 2011 and 2010, Altria Group, Inc.’s long-term debt, all of which was consumer products debt, consisted of the following:

 

(in millions)		2011				2010
Notes, 4.125% to 10.20%, interest payable semi-annually (average coupon interest rate 8.3%), due through 2039		$	13,647			$	12,152
Debenture, 7.75% due 2027, interest payable semi-annually			42				42
			13,689				12,194
Less current portion of long-term debt			600
		$	13,089			$	12,194

Aggregate maturities of long-term debt are as follows:

 

(in millions)		Altria Group, Inc.				UST				Total Long- Term Debt
2012						$	600			$	600
2013		$	1,459								1,459
2014			525								525
2015			1,000								1,000
2018			3,100				300				3,400
2019			2,200								2,200
Thereafter			4,542								4,542

Altria Group, Inc.’s estimate of the fair value of its debt is based on observable market information from a third party pricing source. The aggregate fair value of Altria Group, Inc.’s total long-term debt at December 31, 2011, was $17.7 billion, as compared with its carrying value of $13.7 billion. The aggregate fair value of Altria Group, Inc.’s long-term debt at December 31, 2010, was $15.5 billion, as compared with its carrying value of $12.2 billion.

Altria Group, Inc. Senior Notes:

On May 5, 2011, Altria Group, Inc. issued $1.5 billion (aggregate principal amount) of 4.75% senior unsecured long-term notes due May 5, 2021, with interest payable semi-annually. The net proceeds from the issuances of these senior unsecured notes were added to Altria Group, Inc.’s general funds and used for general corporate purposes.

The notes of Altria Group, Inc. are senior unsecured obligations and rank equally in right of payment with all of Altria Group, Inc.’s existing and future senior unsecured indebtedness. With respect to $12,725 million (aggregate principal amount) of Altria Group, Inc.’s senior unsecured long-term notes that were issued from 2008 to 2011, upon the occurrence of both (i) a change of control of Altria Group, Inc. and (ii) the notes ceasing to be rated investment grade by each of Moody’s, Standard & Poor’s and Fitch Ratings Ltd. within a specified time period, Altria Group, Inc. will be required to make an offer to purchase the notes at a price equal to 101% of the aggregate principal amount of such notes, plus accrued and unpaid interest to the date of repurchase as and to the extent set forth in the terms of the notes.

With respect to $10,225 million (aggregate principal amount) of senior unsecured long-term notes issued in 2008 and 2009, the interest rate payable on each series of notes is subject to adjustment from time to time if the rating assigned to the notes of such series by Moody’s or Standard & Poor’s is downgraded (or subsequently upgraded) as and to the extent set forth in the terms of the notes.

 

22

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

The obligations of Altria Group, Inc. under the notes are guaranteed by PM USA (see Note 20. Condensed Consolidating Financial Information).

UST Senior Notes:

As discussed in Note 3. UST Acquisition, the purchase price for the acquisition of UST included $900 million (aggregate principal amount) of long-term debt consisting of notes that are senior unsecured obligations and rank equally in right of payment with all of UST’s existing and future senior unsecured and unsubordinated indebtedness. With respect to $300 million (aggregate principal amount) of the UST senior notes, upon the occurrence of both (i) a change of control of UST and (ii) these notes ceasing to be rated investment grade by each of Moody’s and Standard & Poor’s within a specified time period, UST would be required to make an offer to purchase these notes at a price equal to 101% of the aggregate principal amount of such series, plus accrued and unpaid interest to the date of repurchase as and to the extent set forth in the terms of these notes.

Note 11. Capital Stock:

Shares of authorized common stock are 12 billion; issued, repurchased and outstanding shares were as follows:

 

		Shares Issued				Shares Repurchased				Shares Outstanding
Balances, December 31, 2008			2,805,961,317				(744,589,733	)			2,061,371,584
Exercise of stock options and issuance of other stock awards							14,657,060				14,657,060
Balances, December 31, 2009			2,805,961,317				(729,932,673	)			2,076,028,644
Exercise of stock options and issuance of other stock awards							12,711,022				12,711,022
Balances, December 31, 2010			2,805,961,317				(717,221,651	)			2,088,739,666
Exercise of stock options and issuance of other stock awards							5,004,502				5,004,502
Repurchases of common stock							(49,324,883	)			(49,324,883	)
Balances, December 31, 2011			2,805,961,317				(761,542,032	)			2,044,419,285

At December 31, 2011, 48,822,217 shares of common stock were reserved for stock options and other stock awards under Altria Group, Inc.’s stock plans, and 10 million shares of Serial Preferred Stock, $1.00 par value, were authorized. No shares of Serial Preferred Stock have been issued.

Note 12. Stock Plans:

Under the Altria Group, Inc. 2010 Performance Incentive Plan (the “2010 Plan”), Altria Group, Inc. may grant to eligible employees stock options, stock appreciation rights, restricted stock, restricted and deferred stock units, and other stock-based awards, as well as cash-based annual and long-term incentive awards. Up to 50 million shares of common stock may be issued under the 2010 Plan. In addition, Altria Group, Inc. may grant up to one million shares of common stock to members of the Board of Directors who are not employees of Altria Group, Inc. under the Stock Compensation Plan for Non-Employee Directors (the “Directors Plan”). Shares available to be granted under the 2010 Plan and the Directors Plan at December 31, 2011, were 47,880,823 and 658,731 respectively.

Restricted and Deferred Stock

Altria Group, Inc. may grant shares of restricted stock and deferred stock to eligible employees. These shares include nonforfeitable rights to dividends or dividend equivalents during the vesting period but may not be sold, assigned,

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

pledged or otherwise encumbered. Such shares are subject to forfeiture if certain employment conditions are not met. Restricted and deferred stock generally vests on the third anniversary of the grant date.

The fair value of the shares of restricted stock and deferred stock at the date of grant is amortized to expense ratably over the restriction period, which is generally three years. Altria Group, Inc. recorded pre-tax compensation expense related to restricted stock and deferred stock granted to employees for the years ended December 31, 2011, 2010 and 2009 of $47 million, $44 million and $61 million, respectively. The deferred tax benefit recorded related to this compensation expense was $18 million, $16 million and $24 million for the years ended December 31, 2011, 2010 and 2009, respectively. The unamortized compensation expense related to Altria Group, Inc. restricted stock and deferred stock was $67 million at December 31, 2011 and is expected to be recognized over a weighted-average period of approximately 2 years.

Altria Group, Inc.’s restricted stock and deferred stock activity was as follows for the year ended December 31, 2011:

 

		Number of Shares				Weighted- Average Grant Date Fair Value Per Share
Balance at December 31, 2010			8,765,598			$	19.72
Granted			2,216,160				24.34
Vested			(2,259,327	)			22.41
Forfeited			(312,015	)			20.84
Balance at December 31, 2011			8,410,416				20.17

The weighted-average grant date fair value of Altria Group, Inc. restricted stock and deferred stock granted during the years ended December 31, 2011, 2010 and 2009 was $54 million, $53 million and $95 million, respectively, or $24.34, $19.90 and $16.71 per restricted or deferred share, respectively. The total fair value of Altria Group, Inc. restricted stock and deferred stock vested during the years ended December 31, 2011, 2010 and 2009 was $56 million, $33 million and $46 million, respectively.

Stock Option Plan

Altria Group, Inc. has not granted stock options to employees since 2002.

Altria Group, Inc. stock option activity was as follows for the year ended December 31, 2011:

 

		Shares Subject to Option				Weighted- Average Exercise Price				Average Remaining Contractual Term				Aggregate Intrinsic Value
Balance at December 31, 2010			2,675,593			$	10.95
Options exercised			(2,637,038	)			10.95
Options canceled			(33,965	)			10.23
Balance/Exercisable at December 31, 2011			4,590				12.48				4 months			$	79 thousand

The aggregate intrinsic value shown in the table above was based on the December 31, 2011 closing price for Altria Group, Inc.’s common stock of $29.65. The total intrinsic value of options exercised during the years ended December 31, 2011, 2010 and 2009 was $37 million, $110 million and $87 million, respectively.

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Note 13. Earnings per Share:

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

 

		For the Years Ended December 31,
(in millions)		2011				2010				2009
Net earnings attributable to Altria Group, Inc.		$	3,390			$	3,905			$	3,206
Less: Distributed and undistributed earnings attributable to unvested restricted and deferred shares			(13	)			(15	)			(11	)
Earnings for basic and diluted EPS		$	3,377			$	3,890			$	3,195
Weighted-average shares for basic EPS			2,064				2,077				2,066
Add: Incremental shares from stock options							2				5
Weighted-average shares for diluted EPS			2,064				2,079				2,071

For the 2011 and 2010 computations, there were no antidilutive stock options. For the 2009 computation, 0.7 million stock options were excluded from the calculation of weighted-average shares for diluted EPS because their effects were antidilutive.

Note 14. Accumulated Other Comprehensive 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.:

 

(in millions)		Currency Translation Adjustments				Changes in Net Loss and Prior Service Cost				Ownership Share of SABMiller’s Other Comprehensive Earnings				Accumulated Other Comprehensive Losses
Balances, December 31, 2008		$	—			$	(2,221	)		$	40			$	(2,181	)
Period change, before income taxes			3				611				372				986
Deferred income taxes							(236	)			(130	)			(366	)
Balances, December 31, 2009			3				(1,846	)			282				(1,561	)
Period change, before income taxes			1				58				63				122
Deferred income taxes							(23	)			(22	)			(45	)
Balances, December 31, 2010			4				(1,811	)			323				(1,484	)
Period change, before income taxes			(2	)			(415	)			(231	)			(648	)
Deferred income taxes							164				81				245
Balances, December 31, 2011		$	2			$	(2,062	)		$	173			$	(1,887	)

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Note 15. Income Taxes:

Earnings before income taxes, and provision for income taxes consisted of the following for the years ended December 31, 2011, 2010 and 2009:

 

(in millions)		2011				2010				2009
Earnings before income taxes:
United States		$	5,568			$	5,709			$	4,868
Outside United States			14				14				9
Total		$	5,582			$	5,723			$	4,877
Provision for income taxes:
Current:
Federal		$	2,353			$	1,430			$	1,512
State and local			275				258				111
Outside United States			4				4				3
			2,632				1,692				1,626
Deferred:
Federal			(458	)			120				(14	)
State and local			15				4				57
			(443	)			124				43
Total provision for income taxes		$	2,189			$	1,816			$	1,669

Altria Group, Inc.’s U.S. subsidiaries join in the filing of a U.S. federal consolidated income tax return. The U.S. federal statute of limitations remains open for the year 2004 and forward, with years 2004 to 2006 currently under examination by the Internal Revenue Service (“IRS”) as part of a routine audit conducted in the ordinary course of business. State jurisdictions have statutes of limitations generally ranging from 3 to 4 years. Certain of Altria Group, Inc.’s state tax returns are currently under examination by various states as part of routine audits conducted in the ordinary course of business.

A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2011, 2010 and 2009 was as follows:

 

(in millions)		2011				2010				2009
Balance at beginning of year		$	399			$	601			$	669
Additions based on tax positions related to the current year			22				21				15
Additions for tax positions of prior years			71				30				34
Reductions for tax positions due to lapse of statutes of limitations			(39	)			(58	)			(22	)
Reductions for tax positions of prior years			(67	)			(164	)			(87	)
Settlements			(5	)			(31	)			(8	)
Balance at end of year		$	381			$	399			$	601

 

26

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Unrecognized tax benefits and Altria Group, Inc.’s consolidated liability for tax contingencies at December 31, 2011 and 2010, were as follows:

 

(in millions)		2011				2010
Unrecognized tax benefits - Altria Group, Inc.		$	191			$	220
Unrecognized tax benefits - Kraft			112				101
Unrecognized tax benefits - PMI			78				78
Unrecognized tax benefits			381				399
Accrued interest and penalties			618				261
Tax credits and other indirect benefits			(211	)			(85	)
Liability for tax contingencies		$	788			$	575

The amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate at December 31, 2011 was $350 million, along with $31 million affecting deferred taxes. However, the impact on net earnings at December 31, 2011 would be $160 million, as a result of receivables from Altria Group, Inc.’s former subsidiaries Kraft Foods Inc. (“Kraft”) and Philip Morris International Inc. (“PMI”) of $112 million and $78 million, respectively, discussed below. The amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate at December 31, 2010 was $360 million, along with $39 million affecting deferred taxes. However, the impact on net earnings at December 31, 2010 would be $181 million, as a result of receivables from Kraft and PMI of $101 million and $78 million, respectively, discussed below.

Under tax sharing agreements entered into in connection with the 2007 and 2008 spin-offs between Altria Group, Inc. and its former subsidiaries Kraft and PMI, respectively, Kraft and PMI are responsible for their respective pre-spin-off tax obligations. Altria Group, Inc., however, remains severally liable for Kraft’s and PMI’s pre-spin-off federal tax obligations pursuant to regulations governing federal consolidated income tax returns. As a result, at December 31, 2011, Altria Group, Inc. continues to include the pre-spin-off federal income tax reserves of Kraft and PMI of $112 million and $78 million, respectively, in its liability for uncertain tax positions, and also includes corresponding receivables from Kraft and PMI of $112 million and $78 million, respectively, in its assets.

In the fourth quarter of 2011, the IRS, Kraft and Altria Group, Inc. executed a closing agreement that resolved certain Kraft tax matters arising out of the IRS’s examination of Altria Group, Inc.’s consolidated federal income tax returns for the years ended 2004-2006. As a result of this closing agreement in the fourth quarter of 2011, Altria Group, Inc. recorded an income tax benefit of $12 million attributable to the reversal of federal income tax reserves and associated interest related to the resolution of certain Kraft tax matters.

As discussed in Note 19. Contingencies, Altria Group, Inc. and the IRS executed a closing agreement during the second quarter of 2010 in connection with the IRS’s examination of Altria Group, Inc.’s consolidated federal income tax returns for the years 2000-2003, which resolved various tax matters for Altria Group, Inc. and its subsidiaries, including its former subsidiaries - Kraft and PMI. As a result of the closing agreement, Altria Group, Inc. paid the IRS approximately $945 million of tax and associated interest during the third quarter of 2010 with respect to certain PMCC leveraged lease transactions referred to by the IRS as lease-in/lease-out (“LILO”) and sale-in/lease-out (“SILO”) transactions, entered into during the 1996-2003 years. During the first quarter of 2011, Altria Group, Inc. filed claims for a refund of the approximately $945 million paid to the IRS. The IRS disallowed the claims during the third quarter of 2011. In addition, as a result of this closing agreement, in the second quarter of 2010, Altria Group, Inc. recorded (i) a $47 million income tax benefit primarily attributable to the reversal of tax reserves and associated interest related to Altria Group, Inc. and its current subsidiaries; and (ii) an income tax benefit of $169 million attributable to the reversal of federal income tax reserves and associated interest related to the resolution of certain Kraft and PMI tax matters.

In the third quarter of 2009, the IRS, Kraft, and Altria Group, Inc. executed a closing agreement that resolved certain Kraft tax matters arising out of the 2000-2003 IRS audit of Altria Group, Inc. As a result of this closing agreement, in the third quarter of 2009, Altria Group, Inc. recorded an income tax benefit of $88 million attributable to the reversal of federal income tax reserves and associated interest related to the resolution of certain Kraft tax matters.

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

The tax benefits of $12 million, $169 million and $88 million, for the years ended December 31, 2011, 2010 and 2009, respectively, were offset by a reduction to the corresponding receivables from Kraft and PMI, which were recorded as reductions to operating income on Altria Group, Inc.’s consolidated statements of earnings for the years ended December 31, 2011, 2010, and 2009, respectively. In addition, during 2011, Altria Group, Inc. recorded an additional tax provision and associated interest of $26 million related to various tax matters for Kraft. This additional tax provision was offset by an increase to the corresponding receivable from Kraft, which was recorded as an increase to operating income on Altria Group, Inc.’s consolidated statement of earnings for the year ended December 31, 2011. For the years ended December 31, 2011, 2010 and 2009, there was no impact on Altria Group, Inc.’s net earnings associated with the Kraft and PMI tax matters discussed above.

Altria Group, Inc. recognizes accrued interest and penalties associated with uncertain tax positions as part of the tax provision. As of December 31, 2011, Altria Group, Inc. had $618 million of accrued interest and penalties, of which approximately $39 million and $21 million related to Kraft and PMI, respectively, for which Kraft and PMI are responsible under their respective tax sharing agreements. As of December 31, 2010, Altria Group, Inc. had $261 million of accrued interest and penalties, of which approximately $32 million and $19 million related to Kraft and PMI, respectively. The corresponding receivables from Kraft and PMI are included in assets on Altria Group, Inc.’s consolidated balance sheets at December 31, 2011 and 2010.

For the years ended December 31, 2011, 2010 and 2009, Altria Group, Inc. recognized in its consolidated statements of earnings $496 million, $(69) million and $3 million, respectively, of gross interest expense (income) associated with uncertain tax positions, which in 2011 primarily relates to the PMCC Leveraged Lease Charge.

Altria Group, Inc. is subject to income taxation in many jurisdictions. Uncertain tax positions reflect the difference between tax positions taken or expected to be taken on income tax returns and the amounts recognized in the financial statements. Resolution of the related tax positions with the relevant tax authorities may take many years to complete, since such timing is not entirely within the control of Altria Group, Inc. It is reasonably possible that within the next 12 months certain examinations will be resolved, which could result in a decrease in unrecognized tax benefits of approximately $250 million, the majority of which would relate to the unrecognized tax benefits of Kraft and PMI, for which Altria Group, Inc. is indemnified.

The effective income tax rate on pre-tax earnings differed from the U.S. federal statutory rate for the following reasons for the years ended December 31, 2011, 2010 and 2009:

 

		2011				2010				2009
U.S. federal statutory rate			35.0	%			35.0	%			35.0	%
Increase (decrease) resulting from:
State and local income taxes, net of federal tax benefit			3.8				3.7				2.4
Uncertain tax positions			5.5				(2.3	)			(0.6	)
SABMiller dividend benefit			(2.0	)			(2.3	)			(2.4	)
Domestic manufacturing deduction			(2.4	)			(2.4	)			(1.5	)
Other			(0.7	)							1.3
Effective tax rate			39.2	%			31.7	%			34.2	%

The tax provision in 2011 includes a $312 million charge that primarily represents a permanent charge for interest, net of income tax benefit, on tax underpayments, associated with the previously discussed PMCC Leveraged Lease Charge which was recorded during the second quarter of 2011 and is reflected in uncertain tax positions above. The tax provision in 2011 also includes tax benefits of $77 million primarily attributable to the reversal of tax reserves and associated interest related to the expiration of statutes of limitations, closure of tax audits and the reversal of tax accruals no longer required. The tax provision in 2010 includes tax benefits of $216 million from the reversal of tax reserves and associated interest resulting from the execution of the 2010 closing agreement with the IRS discussed above. The tax provision in 2010 also includes tax benefits of $64 million from the reversal of tax reserves and associated interest following the resolution of several state audits and the expiration of statutes of limitations. The tax provision in 2009 includes tax benefits of $88 million from the reversal of tax reserves and associated interest resulting from the execution of the

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

2009 closing agreement with the IRS discussed above. The tax provision in 2009 also includes a tax benefit of $53 million from the utilization of net operating losses in the third quarter.

The tax effects of temporary differences that gave rise to consumer products deferred income tax assets and liabilities consisted of the following at December 31, 2011 and 2010:

 

(in millions)		2011				2010
Deferred income tax assets:
Accrued postretirement and postemployment benefits		$	1,087			$	1,045
Settlement charges			1,382				1,393
Accrued pension costs			458				395
Net operating losses and tax credit carryforwards			96				87
Total deferred income tax assets			3,023				2,920
Deferred income tax liabilities:
Property, plant and equipment			(511	)			(425	)
Intangible assets			(3,721	)			(3,655	)
Investment in SABMiller			(1,803	)			(1,758	)
Other			(251	)			(296	)
Total deferred income tax liabilities			(6,286	)			(6,134	)
Valuation allowances			(82	)			(39	)
Net deferred income tax liabilities		$	(3,345	)		$	(3,253	)

Financial services deferred income tax liabilities of $2,811 million and $3,880 million at December 31, 2011 and 2010, respectively, are not included in the table above. These amounts, which are primarily attributable to temporary differences relating to net investments in finance leases, are included in total financial services liabilities on Altria Group, Inc.’s consolidated balance sheets at December 31, 2011 and 2010.

At December 31, 2011, Altria Group, Inc. had estimated state tax net operating losses of $1,267 million that, if unutilized, will expire in 2012 through 2031, state tax credit carryforwards of $78 million which, if unutilized, will expire in 2014 through 2017, and foreign tax credit carryforwards of $31 million which, if unutilized, will expire in 2020 through 2021. A valuation allowance is recorded against certain state net operating losses and tax credit carryforwards due to uncertainty regarding their utilization.

Note 16. Segment Reporting:

The products of Altria Group, Inc.’s consumer products subsidiaries include cigarettes manufactured and sold by PM USA, smokeless products manufactured and sold by or on behalf of USSTC and PM USA, machine-made large cigars and pipe tobacco manufactured and sold by Middleton, 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 cigarettes, smokeless products, cigars, wine and financial services.

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. Information about total assets by segment is not disclosed because such information is not reported to or used by Altria Group, Inc.’s chief operating decision maker. Segment goodwill and other intangible assets, net, are disclosed in Note 4. Goodwill and Other Intangible Assets, net. The accounting policies of the segments are the same as those described in Note 2. Summary of Significant Accounting Policies.

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Segment data were as follows:

 

		For the Years Ended December 31,
(in millions)		2011				2010				2009
Net revenues:
Cigarettes		$	21,403			$	21,631			$	20,919
Smokeless products			1,627				1,552				1,366
Cigars			567				560				520
Wine			516				459				403
Financial services			(313	)			161				348
Net revenues		$	23,800			$	24,363			$	23,556
Earnings before income taxes:
Operating companies income (loss):
Cigarettes		$	5,574			$	5,451			$	5,055
Smokeless products			859				803				381
Cigars			163				167				176
Wine			91				61				43
Financial services			(349	)			157				270
Amortization of intangibles			(20	)			(20	)			(20	)
General corporate expenses			(256	)			(216	)			(204	)
Changes to Kraft and PMI tax-related receivables			14				(169	)			(88	)
UST acquisition-related transaction costs											(60	)
Corporate asset impairment and exit costs			(8	)			(6	)			(91	)
Operating income			6,068				6,228				5,462
Interest and other debt expense, net			(1,216	)			(1,133	)			(1,185	)
Earnings from equity investment in SABMiller			730				628				600
Earnings before income taxes		$	5,582			$	5,723			$	4,877

PM USA, USSTC and Middleton’s largest customer, McLane Company, Inc., accounted for approximately 27%, 27% and 26% of Altria Group, Inc.’s consolidated net revenues for the years ended December 31, 2011, 2010 and 2009, respectively. These net revenues were reported in the cigarettes, smokeless products and cigars segments. Sales to three distributors accounted for approximately 66%, 65% and 64% of net revenues for the wine segment for the years ended December 31, 2011, 2010 and 2009, respectively.

Items affecting the comparability of net revenues and/or operating companies income (loss) for the segments were as follows:

Asset impairment, exit, implementation and integration costs: See Note 5. Asset Impairment, Exit, Implementation and Integration Costs for a breakdown of these costs by segment.

PMCC Leveraged Lease Charge: During 2011, Altria Group, Inc. recorded the PMCC Leveraged Lease Charge, which included a pre-tax charge of $490 million that was recorded as a decrease to PMCC’s net revenues and operating companies income (see Note 8. Finance Assets, net, Note 15. Income Taxes and Note 19. Contingencies for further discussion of matters related to this charge).

PMCC allowance for losses: During 2011, PMCC increased its allowance for losses by $25 million due primarily to American’s bankruptcy filing. During 2009, PMCC increased its allowance for losses by $15 million based on management’s assessment of its portfolio including its exposure to GM. See Note 8. Finance Assets, net.

Tobacco and health judgments: During 2011, Altria Group, Inc. recorded pre-tax charges of $98 million, excluding accrued interest, related to tobacco and health judgments in the Williams, Bullock and Scott cases. These charges are reflected in the cigarettes segment. During 2010, Altria Group, Inc. recorded pre-tax charges of $16 million, excluding accrued interest, related to certain tobacco and health judgments (including a settlement of $5 million)

 

30

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

which are reflected in the cigarettes ($11 million) and smokeless products ($5 million) segments. See Note 19. Contingencies.

 

		For the Years Ended December 31,
(in millions)		2011				2010				2009
Depreciation expense:
Cigarettes		$	142			$	164			$	168
Smokeless products			31				32				41
Cigars			3				3				2
Wine			25				23				22
Corporate			32				34				38
Total depreciation expense		$	233			$	256			$	271
Capital expenditures:
Cigarettes		$	26			$	54			$	147
Smokeless products			24				19				18
Cigars			20				16				4
Wine			25				22				24
Corporate			10				57				80
Total capital expenditures		$	105			$	168			$	273

Effective with the first quarter of 2012, Altria Group, Inc. will revise its reportable segments based on changes in the way in which Altria Group, Inc.’s chief operating decision maker reviews the business. These changes relate to the restructuring associated with the 2011 Cost Reduction Program (see Note 5. Asset Impairment, Exit, Implementation and Integration Costs), specifically the combination of the former cigars and cigarettes segments and evaluation of their operating results as a single smokeable products segment. Beginning in the first quarter of 2012, Altria Group, Inc.’s reportable segments will be smokeable products, smokeless products, wine and financial services.

Note 17. 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.

The plan assets and benefit obligations of Altria Group, Inc.’s pension plans and the benefit obligations of Altria Group, Inc.’s postretirement plans are measured at December 31 of each year.

 

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Notes to Consolidated Financial Statements

 

 

 

Pension Plans

Obligations and Funded Status

The projected benefit obligations, plan assets and funded status of Altria Group, Inc.’s pension plans at December 31, 2011 and 2010, were as follows:

 

(in millions)		2011				2010
Projected benefit obligation at beginning of year		$	6,439			$	6,075
Service cost			74				80
Interest cost			351				356
Benefits paid			(371	)			(375	)
Actuarial losses			460				287
Termination			39
Curtailment			(22	)
Other			(5	)			16
Projected benefit obligation at end of year			6,965				6,439
Fair value of plan assets at beginning of year			5,218				4,870
Actual return on plan assets			188				667
Employer contributions			240				30
Funding of UST plans							26
Benefits paid			(371	)			(375	)
Fair value of plan assets at end of year			5,275				5,218
Net pension liability recognized at December 31		$	(1,690	)		$	(1,221	)

The net pension liability recognized in Altria Group, Inc.’s consolidated balance sheets at December 31, 2011 and 2010, was as follows:

 

(in millions)		2011				2010
Other accrued liabilities		$	(28	)		$	(30	)
Accrued pension costs			(1,662	)			(1,191	)
		$	(1,690	)		$	(1,221	)

The accumulated benefit obligation, which represents benefits earned to date, for the pension plans was $6.6 billion and $6.1 billion at December 31, 2011 and 2010, respectively.

At December 31, 2011 and 2010, the accumulated benefit obligations were in excess of plan assets for all pension plans.

The following assumptions were used to determine Altria Group, Inc.’s benefit obligations under the plans at December 31:

 

		2011				2010
Discount rate			5.0	%			5.5	%
Rate of compensation increase			4.0				4.0

The discount rates for Altria Group, Inc.’s plans were developed from a model portfolio of high-quality corporate bonds with durations that match the expected future cash flows of the benefit obligations.

 

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Notes to Consolidated Financial Statements

 

 

 

Components of Net Periodic Benefit Cost

Net periodic pension cost consisted of the following for the years ended December 31, 2011, 2010 and 2009:

 

(in millions)		2011				2010				2009
Service cost		$	74			$	80			$	96
Interest cost			351				356				349
Expected return on plan assets			(422	)			(421	)			(429	)
Amortization:
Net loss			171				126				119
Prior service cost			14				13				12
Termination, settlement and curtailment			41								12
Net periodic pension cost		$	229			$	154			$	159

During 2011 and 2009, termination, settlement and curtailment shown in the table above primarily reflect termination benefits, partially offset in 2009 by curtailment gains related to Altria Group, Inc.’s restructuring programs. For more information on Altria Group, Inc.’s restructuring programs, see Note 5. Asset Impairment, Exit, Implementation and Integration Costs.

The amounts included in termination, settlement and curtailment in the table above for the years ended December 31, 2011 and 2009 were comprised of the following changes:

 

(in millions)		2011				2009
Benefit obligation		$	39			$	9
Other comprehensive earnings/losses:
Net losses							3
Prior service cost			2
		$	41			$	12

For the pension plans, the estimated net loss and prior service cost that are expected to be amortized from accumulated other comprehensive losses into net periodic benefit cost during 2012 are $224 million and $10 million, respectively.

The following weighted-average assumptions were used to determine Altria Group, Inc.’s net pension cost for the years ended December 31:

 

		2011				2010				2009
Discount rate			5.5	%			5.9	%			6.1	%
Expected rate of return on plan assets			8.0				8.0				8.0
Rate of compensation increase			4.0				4.5				4.5

Altria Group, Inc. sponsors deferred profit-sharing plans covering certain salaried, non-union and union employees. Contributions and costs are determined generally as a percentage of earnings, as defined by the plans. Amounts charged to expense for these defined contribution plans totaled $106 million, $108 million and $106 million in 2011, 2010 and 2009, respectively.

Plan Assets

Altria Group, Inc.’s pension plans investment strategy is based on an expectation that equity securities will outperform debt securities over the long term. Altria Group, Inc. implements the investment strategy in a prudent and risk-controlled manner, consistent with the fiduciary requirements of the Employee Retirement Income Security Act of 1974, by investing retirement plan assets in a well-diversified mix of equities, fixed income and other securities that reflects the impact of the demographic mix of plan participants on the benefit obligation using a target asset allocation

 

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Notes to Consolidated Financial Statements

 

 

 

between equity securities and fixed income investments of 55%/45%. Accordingly, the composition of Altria Group, Inc.’s plan assets at December 31, 2011 was broadly characterized as an allocation between equity securities (53%), corporate bonds (23%), U.S. Treasury and Foreign Government securities (17%) and all other types of investments (7%). Virtually all pension assets can be used to make monthly benefit payments.

Altria Group, Inc.’s pension plans investment strategy is accomplished by investing in U.S. and international equity commingled funds which are intended to mirror indices such as the Standard & Poor’s 500 Index, Russell Small Cap Completeness Index, Morgan Stanley Capital International (“MSCI”) Europe, Australasia, Far East (“EAFE”) Index, and MSCI Emerging Markets Index. Altria Group, Inc.’s pension plans also invest in actively managed international equity securities of large, mid, and small cap companies located in the developed markets of Europe, Australasia, and the Far East, and actively managed long duration fixed income securities that primarily include investment grade corporate bonds of companies from diversified industries, U.S. Treasuries and Treasury Inflation Protected Securities. The below investment grade securities represent 10% of the fixed income holdings or 5% of total plan assets at December 31, 2011. The allocation to emerging markets represents 4% of the equity holdings or 2% of total plan assets at December 31, 2011. The allocation to real estate and private equity investments is immaterial.

Altria Group, Inc.’s pension plans risk management practices include ongoing monitoring of the asset allocation, investment performance, investment managers’ compliance with their investment guidelines, periodic rebalancing between equity and debt asset classes and annual actuarial re-measurement of plan liabilities.

Altria Group, Inc.’s expected rate of return on pension plan assets is determined by the plan assets’ historical long-term investment performance, current asset allocation and estimates of future long-term returns by asset class. The forward-looking estimates are consistent with the overall long-term averages exhibited by returns on equity and fixed income securities.

The fair values of Altria Group, Inc.’s pension plan assets by asset category are as follows:

Investments at Fair value as of December 31, 2011

 

(in millions)		Level 1				Level 2				Level 3				Total
Common/collective trusts:
U.S. large cap		$	—			$	1,482			$	—			$	1,482
U.S. small cap							441								441
International developed markets							152								152
International emerging markets							100								100
Long duration fixed income							585								585
U.S. and foreign government securities or their agencies:
U.S. government and agencies							510								510
U.S. municipal bonds							44								44
Foreign government and agencies							204								204
Corporate debt instruments:
Above investment grade							618								618
Below investment grade and no rating							255								255
Common stock:
International equities			550												550
U.S. equities			21												21
Registered investment companies			124				63								187
U.S. and foreign cash and cash equivalents			42				4								46
Asset backed securities							49								49
Other, net			16				2				13				31
Total investments at fair value, net		$	753			$	4,509			$	13			$	5,275

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Investments at Fair value as of December 31, 2010

 

(in millions)		Level 1				Level 2				Level 3				Total
Common/collective trusts:
U.S. large cap		$	—			$	1,431			$	—			$	1,431
U.S. small cap							533								533
International developed markets							177								177
International emerging markets							123								123
Long duration fixed income							479								479
Other							125								125
U.S. and foreign government securities or their agencies:
U.S. government and agencies							440								440
U.S. municipal bonds							32								32
Foreign government and agencies							308								308
Corporate debt instruments:
Above investment grade							488								488
Below investment grade and no rating							178								178
Common stock:
International equities			542												542
U.S. equities			24												24
Registered investment companies			152				62								214
U.S. and foreign cash and cash equivalents			38				6								44
Asset backed securities							48								48
Other, net			8				11				13				32
Total investments at fair value, net		$	764			$	4,441			$	13			$	5,218

Level 3 holdings are immaterial to total plan assets at December 31, 2011 and 2010.

For a description of the fair value hierarchy and the three levels of inputs used to measure fair value, see Note 2. Summary of Significant Accounting Policies.

Following is a description of the valuation methodologies used for investments measured at fair value, including the general classification of such investments pursuant to the fair value hierarchy.

Common/Collective Trusts: Common/collective trusts consist of pools of investments used by institutional investors to obtain exposure to equity and fixed income markets by investing in equity index funds which are intended to mirror indices such as Standard & Poor’s 500 Index, Russell Small Cap Completeness Index, State Street Global Advisor’s Fundamental Index, MSCI EAFE Index, MSCI Emerging Markets Index, and an actively managed long duration fixed income fund. They are valued on the basis of the relative interest of each participating investor in the fair value of the underlying assets of each of the respective common/collective trusts. The underlying assets are valued based on the net asset value (“NAV”) as provided by the investment account manager and are classified in level 2 of the fair value hierarchy. These common/collective trusts have defined redemption terms which vary from two day prior notice to semi-monthly openings for redemption. There are no other restrictions on redemption at December 31, 2011.

U.S. and Foreign Government Securities: U.S. and Foreign Government securities consist of investments in Treasury Nominal Bonds and Inflation Protected Securities, investment grade municipal securities and unrated or non-investment grade municipal securities. Government securities, which are traded in a non-active over-the-counter market, are valued at a price which is based on a broker quote, and are classified in level 2 of the fair value hierarchy.

Corporate Debt Instruments: Corporate debt instruments are valued at a price which is based on a compilation of primarily observable market information or a broker quote in a non-active over-the-counter market, and are classified in level 2 of the fair value hierarchy.

 

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Notes to Consolidated Financial Statements

 

 

 

Common Stocks: Common stocks are valued based on the price of the security as listed on an open active exchange on last trade date, and are classified in level 1 of the fair value hierarchy.

Registered Investment Companies: Investments in mutual funds sponsored by a registered investment company are valued based on exchange listed prices and are classified in level 1 of the fair value hierarchy. Registered investment company funds which are designed specifically to meet Altria Group, Inc.’s pension plans investment strategies but are not traded on an active market are valued based on the NAV of the underlying securities as provided by the investment account manager on the last business day of the period and are classified in level 2 of the fair value hierarchy. The registered investment company funds measured at NAV have daily liquidity and are not subject to any redemption restrictions at December 31, 2011.

U.S. and Foreign Cash & Cash Equivalents: Cash and cash equivalents are valued at cost that approximates fair value, and are classified in level 1 of the fair value hierarchy. Cash collateral for forward contracts on U.S. Treasury notes, which approximates fair value, is classified in level 2 of the fair value hierarchy.

Asset Backed Securities: Asset backed securities are fixed income securities such as mortgage backed securities and auto loans that are collateralized by pools of underlying assets that are unable to be sold individually. They are valued at a price which is based on a compilation of primarily observable market information or a broker quote in a non-active, over-the-counter market, and are classified in level 2 of the fair value hierarchy.

Cash Flows

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 IRS regulations. On January 3, 2012, Altria Group, Inc. made a voluntary $500 million contribution to its pension plans. Currently, Altria Group, Inc. anticipates making additional employer contributions to its pension plans of approximately $25 million to $50 million in 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.

The estimated future benefit payments from the Altria Group, Inc. pension plans at December 31, 2011, are as follows:

 

(in millions)
2012		$	386
2013			393
2014			416
2015			412
2016			418
2017 - 2021			2,191

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Postretirement Benefit Plans

Net postretirement health care costs consisted of the following for the years ended December 31, 2011, 2010 and 2009:

 

(in millions)		2011				2010				2009
Service cost		$	34			$	29			$	33
Interest cost			139				135				125
Amortization:
Net loss			39				32				36
Prior service credit			(21	)			(21	)			(9	)
Termination and curtailment			(4	)							40
Net postretirement health care costs		$	187			$	175			$	225

During 2011 and 2009, termination and curtailment shown in the table above primarily reflects termination benefits and curtailment gains/losses related to Altria Group, Inc.’s restructuring programs. For further information on Altria Group, Inc.’s restructuring programs, see Note 5. Asset Impairment, Exit, Implementation and Integration Costs.

The amounts included in termination and curtailment shown in the table above for the years ended December 31, 2011 and 2009 were comprised of the following changes:

 

(in millions)		2011				2009
Accrued postretirement health care costs		$	11			$	40
Other comprehensive earnings/losses:
Prior service credit			(15	)
		$	(4	)		$	40

For the postretirement benefit plans, the estimated net loss and prior service credit that are expected to be amortized from accumulated other comprehensive losses into net postretirement health care costs during 2012 are $49 million and $(47) million, respectively.

The following assumptions were used to determine Altria Group, Inc.’s net postretirement cost for the years ended December 31:

 

		2011				2010				2009
Discount rate			5.5	%			5.8	%			6.1	%
Health care cost trend rate			8.0				7.5				8.0

 

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Notes to Consolidated Financial Statements

 

 

 

Altria Group, Inc.’s postretirement health care plans are not funded. The changes in the accumulated postretirement benefit obligation at December 31, 2011 and 2010, were as follows:

 

(in millions)		2011				2010
Accrued postretirement health care costs at beginning of year		$	2,548			$	2,464
Service cost			34				29
Interest cost			139				135
Benefits paid			(136	)			(118	)
Plan amendments			(282	)			(58	)
Assumption changes							124
Actuarial losses/(gains)			191				(28	)
Termination and curtailment			11
Accrued postretirement health care costs at end of year		$	2,505			$	2,548

The current portion of Altria Group, Inc.’s accrued postretirement health care costs of $146 million at December 31, 2011 and 2010, is included in other accrued liabilities on the consolidated balance sheets.

The Patient Protection and Affordable Care Act (“PPACA”), as amended by the Health Care and Education Reconciliation Act of 2010, was signed into law in March 2010. The PPACA mandates health care reforms with staggered effective dates from 2010 to 2018, including the imposition of an excise tax on high cost health care plans effective 2018. The additional accumulated postretirement liability resulting from the PPACA, which is not material to Altria Group, Inc., has been included in Altria Group, Inc.’s accumulated postretirement benefit obligation at December 31, 2011 and 2010. Given the complexity of the PPACA and the extended time period during which implementation is expected to occur, further adjustments to Altria Group, Inc.’s accumulated postretirement benefit obligation may be necessary in the future.

The following assumptions were used to determine Altria Group, Inc.’s postretirement benefit obligations at December 31:

 

		2011				2010
Discount rate			4.9	%			5.5	%
Health care cost trend rate assumed for next year			8.0				8.0
Ultimate trend rate			5.0				5.0
Year that the rate reaches the ultimate trend rate			2018				2017

Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects as of December 31, 2011:

 

		One- Percentage- Point Increase				One- Percentage- Point Decrease
Effect on total of service and interest cost			13.3	%			(10.6	)%
Effect on postretirement benefit obligation			7.9				(6.7	)

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Altria Group, Inc.’s estimated future benefit payments for its postretirement health care plans at December 31, 2011, are as follows:

 

(in millions)
2012		$	146
2013			158
2014			167
2015			173
2016			176
2017-2021			851

Postemployment Benefit Plans

Altria Group, Inc. sponsors postemployment benefit plans covering substantially all salaried and certain hourly employees. The cost of these plans is charged to expense over the working life of the covered employees. Net postemployment costs consisted of the following for the years ended December 31, 2011, 2010 and 2009:

 

(in millions)		2011				2010				2009
Service cost		$	1			$	1			$	1
Interest cost			2				1				1
Amortization of net loss			16				12				11
Other			121				5				178
Net postemployment costs		$	140			$	19			$	191

“Other” postemployment cost shown in the table above primarily reflects incremental severance costs related to Altria Group, Inc.’s restructuring programs (see Note 5. Asset Impairment, Exit, Implementation and Integration Costs).

For the postemployment benefit plans, the estimated net loss that is expected to be amortized from accumulated other comprehensive losses into net postemployment costs during 2012 is approximately $18 million.

Altria Group, Inc.’s postemployment benefit plans are not funded. The changes in the benefit obligations of the plans at December 31, 2011 and 2010, were as follows:

 

(in millions)		2011				2010
Accrued postemployment costs at beginning of year		$	151			$	349
Service cost			1				1
Interest cost			2				1
Benefits paid			(48	)			(218	)
Actuarial losses and assumption changes			43				13
Other			121				5
Accrued postemployment costs at end of year		$	270			$	151

The accrued postemployment costs were determined using a weighted-average discount rate of 2.8% and 3.8% in 2011 and 2010, respectively, an assumed weighted-average ultimate annual turnover rate of 1.0% in 2011 and 0.5% in 2010, assumed compensation cost increases of 4.0% in 2011 and 2010, and assumed benefits as defined in the respective plans. Postemployment costs arising from actions that offer employees benefits in excess of those specified in the respective plans are charged to expense when incurred.

 

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Comprehensive Earnings/Losses:

The amounts recorded in accumulated other comprehensive losses at December 31, 2011 consisted of the following:

 

(in millions)		Pensions				Post- retirement				Post- employment				Total
Net losses		$	(2,788	)		$	(796	)		$	(175	)		$	(3,759	)
Prior service (cost) credit			(46	)			425								379
Deferred income taxes			1,104				146				68				1,318
Amounts recorded in accumulated other comprehensive losses		$	(1,730	)		$	(225	)		$	(107	)		$	(2,062	)

The amounts recorded in accumulated other comprehensive losses at December 31, 2010 consisted of the following:

 

(in millions)		Pensions				Post- retirement				Post- employment				Total
Net losses		$	(2,287	)		$	(647	)		$	(151	)		$	(3,085	)
Prior service (cost) credit			(62	)			182								120
Deferred income taxes			914				180				60				1,154
Amounts recorded in accumulated other comprehensive losses		$	(1,435	)		$	(285	)		$	(91	)		$	(1,811	)

The movements in other comprehensive earnings/losses during the year ended December 31, 2011 were as follows:

 

(in millions)		Pensions				Post- retirement				Post- employment				Total
Amounts transferred to earnings as components of net periodic benefit cost:
Amortization:
Net losses		$	171			$	39			$	16			$	226
Prior service cost/credit			14				(21	)							(7	)
Deferred income taxes			(72	)			(7	)			(6	)			(85	)
			113				11				10				134
Other movements during the year:
Net losses			(672	)			(188	)			(40	)			(900	)
Prior service cost/credit			2				264								266
Deferred income taxes			262				(27	)			14				249
			(408	)			49				(26	)			(385	)
Total movements in other comprehensive earnings/losses		$	(295	)		$	60			$	(16	)		$	(251	)

 

40

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

The movements in other comprehensive earnings/losses during the year ended December 31, 2010 were as follows:

 

(in millions)		Pensions				Post- retirement				Post- employment				Total
Amounts transferred to earnings as components of net periodic benefit cost:
Amortization:
Net losses		$	126			$	32			$	12			$	170
Prior service cost/credit			13				(21	)							(8	)
Deferred income taxes			(55	)			(4	)			(4	)			(63	)
			84				7				8				99
Other movements during the year:
Net losses			(41	)			(95	)			(10	)			(146	)
Prior service cost/credit			(16	)			58								42
Deferred income taxes			21				15				4				40
			(36	)			(22	)			(6	)			(64	)
Total movements in other comprehensive earnings/losses		$	48			$	(15	)		$	2			$	35

The movements in other comprehensive earnings/losses during the year ended December 31, 2009 were as follows:

 

(in millions)		Pensions				Post- retirement				Post- employment				Total
Amounts transferred to earnings as components of net periodic benefit cost:
Amortization:
Net losses		$	119			$	36			$	11			$	166
Prior service cost/credit			12				(9	)							3
Other expense:
Net losses			3												3
Deferred income taxes			(52	)			(10	)			(4	)			(66	)
			82				17				7				106
Other movements during the year:
Net losses			413				(25	)			(24	)			364
Prior service cost/credit							75								75
Deferred income taxes			(161	)			(19	)			10				(170	)
			252				31				(14	)			269
Total movements in other comprehensive earnings/losses		$	334			$	48			$	(7	)		$	375

 

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Notes to Consolidated Financial Statements

 

 

 

Note 18. Additional Information:

 

		For the Years Ended December 31,
(in millions)		2011				2010				2009
Research and development expense		$	128			$	144			$	177
Advertising expense		$	5			$	5			$	6
Interest and other debt expense, net:
Interest expense		$	1,220			$	1,136			$	1,189
Interest income			(4	)			(3	)			(4	)
		$	1,216			$	1,133			$	1,185
Interest expense of financial services operations included in cost of sales		$	—			$	—			$	20
Rent expense		$	63			$	58			$	55

Minimum rental commitments and sublease income under non-cancelable operating leases, including amounts associated with closed facilities primarily from the integration of UST (see Note 5. Asset Impairment, Exit, Implementation and Integration Costs), in effect at December 31, 2011, were as follows:

 

(in millions)		Rental Commitments				Sublease Income
2012		$	56			$	2
2013			46				3
2014			37				3
2015			25				4
2016			21				4
Thereafter			110				29
		$	295			$	45

Note 19. 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.

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

 

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Notes to Consolidated Financial Statements

 

 

 

remains a risk that such relief may not be obtainable in all cases. This risk has been substantially reduced given that 44 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 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 19. 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 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.

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 December 31, 2011, December 31, 2010 and December 31, 2009.

 

Type of Case		Number of Cases Pending as of December 31, 2011				Number of Cases Pending as of December 31, 2010				Number of Cases Pending as of December 31, 2009
Individual Smoking and Health Cases (1)			82				92				89
Smoking and Health Class Actions and Aggregated Claims Litigation (2)			7				11				7
Health Care Cost Recovery Actions			1				4				3
“Lights/Ultra Lights” Class Actions			18				27				28
Tobacco Price Cases			1				1				2

 

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(1)

Does not include 2,586 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, 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. Plaintiffs have appealed.

Also, does not include approximately 6,561 individual smoking and health cases (3,301 state court cases and 3,260 federal court cases) brought by or on behalf of approximately 8,126 plaintiffs in Florida (4,867 state court plaintiffs and 3,259 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 613 civil actions (of which 352 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 plaintiffs’ entitlement to punitive damages would be determined 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 on November 8, 2011. The court has not yet scheduled a new trial.

International Tobacco-Related Cases

As of December 31, 2011, PM USA is a named defendant in Israel in one “Lights” class action and one health care cost recovery 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 PMI that provides for indemnities for certain liabilities concerning tobacco products.

Pending and Upcoming Tobacco-Related Trials

As of December 31, 2011, 45 Engle progeny cases and 2 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.

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, fourteen 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

 

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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 January 26, 2012, twenty-seven 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 thirteen 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 $177.1 million and interest totaling approximately $80.0 million as of December 31, 2011. As described below, PM USA recorded provisions for Bullock and Williams in the fourth quarter of 2011 and paid the Williams judgment on January 20, 2012.

Security for Judgments

To obtain stays of judgments pending current appeals, as of December 31, 2011, PM USA has posted various forms of security totaling approximately $63 million, the majority of which has been collateralized with cash deposits that are included in other assets on the 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 2011 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 on November 4, 2011.

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 transferred 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 March 2008, plaintiffs and PM USA appealed to the California Supreme Court. In April 2008, the California Supreme Court

 

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denied both petitions for review. In July 2008, $43.3 million of escrow funds were returned to PM USA. The case was remanded to the superior court for a new trial on the amount of punitive damages, if any. In August 2009, the jury returned a verdict, and in December 2009, the superior court entered a judgment, awarding plaintiff $13.8 million in punitive damages, plus costs. In December 2009, PM USA filed a motion for judgment notwithstanding the verdict seeking a reduction of the punitive damages award, which motion was denied in January 2010. PM USA noticed an appeal in February 2010 and posted an appeal bond of approximately $14.7 million. In August 2011, the California Court of Appeal affirmed the final judgment entered in favor of the plaintiffs. On November 30, 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. As of December 31, 2011, PM USA recorded a total pre-tax provision of $14.7 million related to damages and costs and $4.1 million related to interest. These amounts are included in other accrued liabilities on Altria Group, Inc.’s consolidated balance sheet at December 31, 2011.

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 is set to begin on January 30, 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. On December 2, 2011, the Oregon Supreme Court reversed the trial court and ruled that PM USA is required to pay the state the sixty percent portion of the punitive damages award. On December 16, 2011, PM USA filed a petition for rehearing before the Oregon Supreme Court, which the Oregon Supreme Court denied on January 12, 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 interest. These amounts are included in other accrued liabilities on Altria Group, Inc.’s consolidated balance sheet at December 31, 2011. On January 20, 2012, PM USA paid an amount of approximately $102 million in satisfaction of the judgment and associated costs and interest.

 

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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 December 31, 2011, approximately 6,561 cases (3,301 state court cases and 3,260 federal court cases) were pending against PM USA or Altria Group, Inc. asserting individual claims by or on behalf of approximately 8,126 plaintiffs, 4,867 state court plaintiffs and 3,259 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 on December 20, 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 are seeking review of the due process ruling by the United States Court of Appeals for the Eleventh Circuit.

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 31 active cases pending in federal court. Discovery is proceeding in these cases and the first trial is set to begin on February 7, 2012.

 

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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 January 26, 2012, twenty-seven Engle progeny cases involving PM USA have resulted in verdicts since the Florida Supreme Court Engle decision. Fourteen verdicts (see Hess, Barbanell, F. Campbell, Naugle, Douglas, R. Cohen, Putney, Kayton (formerly Tate), Piendle, Hatziyannakis, Huish, Tullo, Allen and Hallgren descriptions in the table below) were returned in favor of plaintiffs and thirteen verdicts were returned in favor of PM USA (Gelep, Kalyvas, Gil de Rubio, Warrick, Willis, Frazier, C. Campbell, Rohr, Espinosa, Oliva, Weingart, Junious and Szymanski). 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. For a further discussion of this case, see the verdict chart below. In addition, there have been a number of mistrials, only some of which have resulted in new trials as of January 26, 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.

The chart below lists the verdicts and post-trial developments in the Engle progeny cases that were pending during 2011 and 2012 in which verdicts were returned in favor of plaintiffs.

 

Date		Plaintiff		Verdict		Post-Trial Developments
January 2012		Hallgren		On January 26, 2012, 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.
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 has 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 posted a bond in the amount of $5,000 on November 14, 2011.

 

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Date		Plaintiff		Verdict		Post-Trial Developments
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. Argument was heard in June 2011. 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 $1,250,000 on November 4, 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 PM USA.		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.
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.

 

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Date		Plaintiff		Verdict		Post-Trial Developments
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 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.		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.
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. Argument on the merits of the appeal was heard in October 2011.
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

 

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Date		Plaintiff		Verdict		Post-Trial Developments
						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.
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 $156,000 in damages against PM USA due to the jury allocating only 2% of the fault to PM USA.		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 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. On December 16, 2011, PM USA and Liggett Group filed a joint petition for a writ of certiorari with the United States Supreme Court. R.J. Reynolds filed a separate petition for a writ of certiorari on December 16, 2011. As of December 31, 2011, PM USA has recorded a provision of approximately $242,000 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 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.
February		Hess		A Broward County jury found in favor		PM USA noticed an appeal to the

 

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Date		Plaintiff		Verdict		Post-Trial Developments
2009				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.		Fourth District Court of Appeal in July 2009. Argument was heard in March 2011.

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. On December 16, 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.

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.

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).

 

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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.

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. As of March 31, 2011, PM USA recorded a provision of $26 million in connection with the case and additional provisions of approximately $3.7 million related to accrued interest. In the second quarter of 2011, after the June 2011 United States Supreme Court denial of defendants’ petition for a writ of certiorari, PM USA recorded an additional provision of approximately $36 million related to the judgment and approximately $5 million related to interest.

In August 2011, PM USA paid its share of the judgment 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. On October 31, 2011, plaintiffs’ counsel filed a motion for an award of attorneys’ fees and costs. Plaintiffs’ counsel seek additional fees from defendants ranging from $91 million to $642 million. Additionally, plaintiffs’ counsel request an award of approximately $13 million in costs. As of December 31, 2011, PM USA has recorded a provision of approximately $1.3 million for costs, but is opposing plaintiffs’ counsel’s request for additional costs and for fees. Argument on whether defendants can be held liable for attorneys’ fees is scheduled for February 3, 2012.

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

 

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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 plaintiffs have appealed that decision to the United States Court of Appeals for the Second Circuit. Argument has been set for 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. Trial has been postponed. In June 2011, plaintiffs filed various motions for summary judgment and to strike affirmative defenses. On October 31, 2011, PM USA filed a motion for class decertification. Argument is scheduled for January 27, 2012.

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.

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.

 

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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 plaintiffs’ appeals from the cases decided by five circuit courts of appeals.

In April 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, the jury returned a verdict in favor of the defendants on all counts. In June 2011, the litigation was concluded in a consent judgment pursuant to which the plaintiffs waived all rights to appeal in exchange for the defendants’ waiver of any claim for costs.

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 (1), the Marshall Islands (dismissed), and Canada (4), and other entities have stated that they are considering filing such actions. In the case in Israel, 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.

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.

 

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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 years ended December 31, 2011, 2010 and 2009, 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 $4.8 billion, $4.8 billion and $5.0 billion, respectively.

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 2010

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 2010. 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”

 

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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 and 2008 on February 1, 2010 and February 1, 2011, respectively, and will become effective for 2009 on February 1, 2012. The MSA’s Independent Auditor has determined that the participating manufacturers collectively lost market share for 2010. Subsequent to that determination, the OPMs and the states have agreed to extend the significant factor agreement to apply to such collective loss of market share for 2010, as well as to any collective loss of market share that the participating manufacturers experience for 2011-2012. This agreement will become effective for 2010 on February 1, 2013. If the Independent Auditor determines that the participating manufacturers collectively lost market share for 2011 or 2012, this agreement will become effective for 2011 on February 1, 2014 and 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.

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 2010 have not yet been scheduled.

 

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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 NPM Adjustment shown below into the MSA’s disputed payments account in connection with its MSA payment due in 2011. The approximate maximum principal amounts of PM USA’s share of the disputed NPM Adjustment for the years 2003 through 2010, 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):

 

Year for which NPM Adjustment calculated			2003				2004				2005				2006				2007				2008				2009				2010
Year in which deduction for NPM Adjustment may be taken			2006				2007				2008				2009				2010				2011				2012				2013
PM USA’s Approximate Share of Disputed NPM Adjustment (in millions)		$	337			$	388			$	181			$	154			$	207			$	267			$	211			$	209

The foregoing amounts may be recalculated by the 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 2003-2010 will not be finally determined until 2012 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 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 in the form of a withdrawal from the disputed payments account.

PM USA intends to pursue vigorously the disputed NPM Adjustments for 2003-2010 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 - 2010, the use of an incorrect conversion method resulted in excess MSA payments by PM USA of approximately $85 million in the aggregate.

 

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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 years subsequent to 2010.

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 anticipates that this arbitration will not be concluded until later in 2012 or thereafter.

No assurance can be given that PM USA will prevail on either of these disputes.

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. Argument was heard in October 2011.

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 (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 have filed a motion to modify the judgment and a notice of appeal.

In addition to the Pryor 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

 

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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:

 

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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;

 

•

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.

 

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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:

 

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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.

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

 

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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 is scheduled for 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. On November 17, 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. On January 26, 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.

On December 14, 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.

“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, express preemption by the Federal Cigarette Labeling and Advertising Act (“FCLAA”) and implied preemption by the policies and directives of the FTC, non-liability under state statutory provisions exempting conduct that complies with federal regulatory directives, and the First Amendment. As of December 31, 2011, 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. Other entities have stated that they are considering filing such actions against Altria Group, Inc. and PM USA.

In the one “Lights” case pending in Israel, 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 FCLAA and dismissed

 

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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 with the United States Supreme Court, 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 December 31, 2011, 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. On December 12, 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 courts in which the suits originated. The question of the transfer, which defendants oppose, is now before the JPMDL.

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

To date, in addition to the district court in the MDL proceeding, 15 courts in 16 “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.

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

 

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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 on November 15, 2011.

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 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 Watson case to Arkansas state court. On December 19, 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 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.

 

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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 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.

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:

 

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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). Argument on plaintiffs’ motion was held in July 2011.

 

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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

 

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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. On August 31, 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.

 

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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.

Certain Other Tobacco-Related Litigation

Tobacco Price Case: As of December 31, 2011, 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. Trial has been set for July 16, 2012.

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 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

 

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denied in December 2010. Defendants sought review of this decision before the Fourth District Court of Appeal but were denied review in March 2011. On January 9, 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 March 21, 2012. Trial is currently scheduled for October 5, 2012.

Ignition Propensity Cases: PM USA is currently a defendant in two wrongful death actions in which plaintiffs contend that fires caused by cigarettes led to other individuals’ deaths. In one case pending 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. Argument was heard in March 2011. 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. On October 31, 2011, the United States Court of Appeals for the Sixth Circuit (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 on December 8, 2011.

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 health care cost reimbursement/third-party recoupment/class action litigation against the major domestic cigarette companies and others seeking damages and other relief. The complaints in these cases on their face predominantly relate to the usage of cigarettes; within that context, certain complaints contain a few allegations relating specifically to smokeless tobacco products. These actions are in varying stages of pretrial activities.

Second, 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.

Third, 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).

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.

 

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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. 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 and did not include such amounts in the supplemental disclosure of cash paid for income taxes on the consolidated statement of cash flows. 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.’s consolidated balance sheet at December 31, 2011 reflects reductions in both Other assets and tax liabilities of 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. This payment has been included in the supplemental disclosure of cash paid for income taxes on the consolidated statement of cash flows for the year ended December 31, 2011. The impact of these payments on Altria Group, Inc.’s earnings has previously been recorded on its financial statements, as

 

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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 the 2011 tax year 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 December 31, 2011 and excludes additional taxes paid in 2011 for the 2010 and 2011 tax years as a result of the decision discussed below not to claim tax benefits for the 2010 and future tax years. 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 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.

 

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As of December 31, 2011, the LILO and SILO transactions represented approximately 30% 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 Corporate 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 Altria Group, Inc. defendants deny any violation of ERISA or other unlawful conduct and are defending these cases vigorously. The parties are currently in mediation. Absent a resolution, trial in both cases is expected to be scheduled to occur in the first half of 2012. Under the terms of a Distribution Agreement between Altria Group, Inc. and Kraft, 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. On November 9, 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.

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

 

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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 December 31, 2011, subsidiaries of Altria Group, Inc. were also contingently liable for $29 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 a 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 consolidated balance sheet at December 31, 2011 as the fair value of this indemnification is insignificant.

As more fully discussed in Note 20. Condensed Consolidating Financial Information, PM USA 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.

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 December 31, 2011, 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 in the 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 in the consolidated balance sheets at December 31, 2011 and 2010.

 

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Note 20. 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 December 31, 2011, 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 December 31, 2011 and 2010, condensed consolidating statements of earnings for the years ended December 31, 2011, 2010 and 2009, and condensed consolidating statements of cash flows for the years ended December 31, 2011, 2010 and 2009 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.

 

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Condensed Consolidating Balance Sheets

(in millions of dollars)

 

December 31, 2011		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				342								(7,351	)
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				7,638				21,434				(19,483	)			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			$	7,638			$	25,303			$	(19,775	)		$	36,962

 

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Condensed Consolidating Balance Sheets (continued)

(in millions of dollars)

 

December 31, 2011		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				408				8,238				(8,646	)			5,674
Earnings reinvested in the business			23,583				393				265				(658	)			23,583
Accumulated other comprehensive losses			(1,887	)			(313	)			(1,649	)			1,962				(1,887	)
Cost of repurchased stock			(24,625	)															(24,625	)
Total stockholders’ equity attributable to Altria Group, Inc.			3,680				488				6,863				(7,351	)			3,680
Noncontrolling interests											3								3
Total stockholders’ equity			3,680				488				6,866				(7,351	)			3,683
Total Liabilities and Stockholders’ Equity		$	23,796			$	7,638			$	25,303			$	(19,775	)		$	36,962

 

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Condensed Consolidating Balance Sheets

(in millions of dollars)

 

December 31, 2010		Altria Group, Inc.				PM USA				Non- Guarantor Subsidiaries				Total Consolidating Adjustments				Consolidated
Assets
Consumer products
Cash and cash equivalents		$	2,298			$	—			$	16			$	—			$	2,314
Receivables			1				9				75								85
Inventories:
Leaf tobacco							594				366								960
Other raw materials							121				39								160
Work in process											299								299
Finished product							145				239								384
							860				943								1,803
Due from Altria Group, Inc. and subsidiaries			429				2,902				1,556				(4,887	)
Deferred income taxes			18				1,190								(43	)			1,165
Other current assets			64				420				130								614
Total current assets			2,810				5,381				2,720				(4,930	)			5,981
Property, plant and equipment, at cost			2				3,749				1,399								5,150
Less accumulated depreciation			2				2,343				425								2,770
							1,406				974								2,380
Goodwill											5,174								5,174
Other intangible assets, net							2				12,116								12,118
Investment in SABMiller			5,367																5,367
Investment in consolidated subsidiaries			7,561				325								(7,886	)
Due from Altria Group, Inc. and subsidiaries			6,500												(6,500	)
Other assets			1,511				680				98				(438	)			1,851
Total consumer products assets			23,749				7,794				21,082				(19,754	)			32,871
Financial services
Finance assets, net											4,502								4,502
Due from Altria Group, Inc. and subsidiaries											690				(690	)
Other assets											29								29
Total financial services assets											5,221				(690	)			4,531
Total Assets		$	23,749			$	7,794			$	26,303			$	(20,444	)		$	37,402

 

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Condensed Consolidating Balance Sheets (continued)

(in millions of dollars)

 

December 31, 2010		Altria Group, Inc.				PM USA				Non- Guarantor Subsidiaries				Total Consolidating Adjustments				Consolidated
Liabilities
Consumer products
Accounts payable		$	—			$	215			$	314			$	—			$	529
Accrued liabilities:
Marketing							347				100								447
Taxes, except income taxes							212				19								231
Employment costs			30				18				184								232
Settlement charges							3,531				4								3,535
Other			312				467				333				(43	)			1,069
Dividends payable			797																797
Due to Altria Group, Inc. and subsidiaries			3,674				454				1,449				(5,577	)
Total current liabilities			4,813				5,244				2,403				(5,620	)			6,840
Long-term debt			11,295								899								12,194
Deferred income taxes			1,800								3,256				(438	)			4,618
Accrued pension costs			204								987								1,191
Accrued postretirement health care costs							1,500				902								2,402
Due to Altria Group, Inc. and subsidiaries											6,500				(6,500	)
Other liabilities			445				335				169								949
Total consumer products liabilities			18,557				7,079				15,116				(12,558	)			28,194
Financial services
Deferred income taxes											3,880								3,880
Other liabilities											101								101
Total financial services liabilities											3,981								3,981
Total liabilities			18,557				7,079				19,097				(12,558	)			32,175
Contingencies
Redeemable noncontrolling interest											32								32
Stockholders’ Equity
Common stock			935								9				(9	)			935
Additional paid-in capital			5,751				408				8,217				(8,625	)			5,751
Earnings reinvested in the business			23,459				583				385				(968	)			23,459
Accumulated other comprehensive losses			(1,484	)			(276	)			(1,440	)			1,716				(1,484	)
Cost of repurchased stock			(23,469	)															(23,469	)
Total stockholders’ equity attributable to Altria Group, Inc.			5,192				715				7,171				(7,886	)			5,192
Noncontrolling interests											3								3
Total stockholders’ equity			5,192				715				7,174				(7,886	)			5,195
Total Liabilities and Stockholders’ Equity		$	23,749			$	7,794			$	26,303			$	(20,444	)		$	37,402

 

77

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Notes to Consolidated Financial Statements

 

 

 

Condensed Consolidating Statements of Earnings

(in millions of dollars)

 

for the year ended December 31, 2011		Altria Group, Inc.				PM USA				Non- Guarantor Subsidiaries				Total Consolidating Adjustments				Consolidated
Net revenues		$	—			$	21,330			$	2,496			$	(26	)		$	23,800
Cost of sales							6,883				823				(26	)			7,680
Excise taxes on products							6,846				335								7,181
Gross profit							7,601				1,338								8,939
Marketing, administration and research costs			186				2,164				293								2,643
Changes to Kraft and PMI tax-related receivables			(14	)															(14	)
Asset impairment and exit costs			8				200				14								222
Amortization of intangibles											20								20
Operating (expense) income			(180	)			5,237				1,011								6,068
Interest and other debt expense, net			698				61				457								1,216
Earnings from equity investment in SABMiller			(730	)															(730	)
(Loss) earnings before income taxes and equity earnings of subsidiaries			(148	)			5,176				554								5,582
(Benefit) provision for income taxes			(199	)			1,930				458								2,189
Equity earnings of subsidiaries			3,339				64								(3,403	)
Net earnings			3,390				3,310				96				(3,403	)			3,393
Net earnings attributable to noncontrolling interests											(3	)							(3	)
Net earnings attributable to Altria Group, Inc.		$	3,390			$	3,310			$	93			$	(3,403	)		$	3,390

 

78

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Notes to Consolidated Financial Statements

 

 

 

Condensed Consolidating Statements of Earnings

(in millions of dollars)

 

for the year ended December 31, 2010		Altria Group, Inc.				PM USA				Non- Guarantor Subsidiaries				Total Consolidating Adjustments				Consolidated
Net revenues		$	—			$	21,580			$	2,809			$	(26	)		$	24,363
Cost of sales							6,990				740				(26	)			7,704
Excise taxes on products							7,136				335								7,471
Gross profit							7,454				1,734								9,188
Marketing, administration and research costs			147				2,280				308								2,735
Changes to Kraft and PMI tax-related receivables			169																169
Asset impairment and exit costs							24				12								36
Amortization of intangibles											20								20
Operating (expense) income			(316	)			5,150				1,394								6,228
Interest and other debt expense, net			549				2				582								1,133
Earnings from equity investment in SABMiller			(628	)															(628	)
(Loss) earnings before income taxes and equity earnings of subsidiaries			(237	)			5,148				812								5,723
(Benefit) provision for income taxes			(329	)			1,864				281								1,816
Equity earnings of subsidiaries			3,813				46								(3,859	)
Net earnings			3,905				3,330				531				(3,859	)			3,907
Net earnings attributable to noncontrolling interests											(2	)							(2	)
Net earnings attributable to Altria Group, Inc.		$	3,905			$	3,330			$	529			$	(3,859	)		$	3,905

 

79

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Notes to Consolidated Financial Statements

 

 

 

Condensed Consolidating Statements of Earnings

(in millions of dollars)

 

for the year ended December 31, 2009		Altria Group, Inc.				PM USA				Non- Guarantor Subsidiaries				Total Consolidating Adjustments				Consolidated
Net revenues		$	—			$	20,922			$	2,634			$	—			$	23,556
Cost of sales							7,332				658								7,990
Excise taxes on products							6,465				267								6,732
Gross profit							7,125				1,709								8,834
Marketing, administration and research costs			234				2,180				429								2,843
Changes to Kraft and PMI tax-related receivables			88																88
Asset impairment and exit costs							142				279								421
Amortization of intangibles							11				9								20
Operating (expense) income			(322	)			4,792				992								5,462
Interest and other debt expense (income), net			579				(3	)			609								1,185
Earnings from equity investment in SABMiller			(600	)															(600	)
(Loss) earnings before income taxes and equity earnings of subsidiaries			(301	)			4,795				383								4,877
(Benefit) provision for income taxes			(313	)			1,882				100								1,669
Equity earnings of subsidiaries			3,194												(3,194	)
Net earnings			3,206				2,913				283				(3,194	)			3,208
Net earnings attributable to noncontrolling interests											(2	)							(2	)
Net earnings attributable to Altria Group, Inc.		$	3,206			$	2,913			$	281			$	(3,194	)		$	3,206

 

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Notes to Consolidated Financial Statements

 

 

 

Condensed Consolidating Statements of Cash Flows

(in millions of dollars)

 

for the year ended December 31, 2011		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		$	(151	)		$	3,562			$	202			$	—			$	3,613
Cash Provided by (Used in) Investing Activities
Consumer products
Capital expenditures							(26	)			(79	)							(105	)
Other							1				1								2
Financial services
Proceeds from finance assets											490								490
Net cash (used in) provided by investing activities							(25	)			412								387
Cash Provided by (Used in) Financing Activities
Consumer products
Long-term debt issued			1,494																1,494
Repurchases of common stock			(1,327	)															(1,327	)
Dividends paid on common stock			(3,222	)															(3,222	)
Issuances of common stock			29																29
Changes in amounts due to/from Altria Group, Inc. and subsidiaries			441				(28	)			(413	)
Financing fees and debt issuance costs			(24	)															(24	)
Cash dividends received from/(paid by) subsidiaries			3,666				(3,453	)			(213	)
Other			41				(56	)			21								6
Net cash provided by (used in) financing activities			1,098				(3,537	)			(605	)							(3,044	)
Cash and cash equivalents:
Increase			947				—				9				—				956
Balance at beginning of year			2,298								16								2,314
Balance at end of year		$	3,245			$	—			$	25			$	—			$	3,270

 

81

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Notes to Consolidated Financial Statements

 

 

 

Condensed Consolidating Statements of Cash Flows

(in millions of dollars)

 

for the year ended December 31, 2010		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		$	(712	)		$	2,993			$	486			$	—			$	2,767
Cash Provided by (Used in) Investing Activities
Consumer products
Capital expenditures							(54	)			(114	)							(168	)
Other							3				112								115
Financial services
Proceeds from finance assets											312								312
Net cash (used in) provided by investing activities							(51	)			310								259
Cash Provided by (Used in) Financing Activities
Consumer products
Long-term debt issued			1,007																1,007
Long-term debt repaid			(775	)															(775	)
Dividends paid on common stock			(2,958	)															(2,958	)
Issuances of common stock			104																104
Changes in amounts due to/from Altria Group, Inc. and subsidiaries			279				325				(604	)
Financing fees and debt issuance costs			(6	)															(6	)
Cash dividends received from/(paid by) subsidiaries			3,438				(3,259	)			(179	)
Other			59				(8	)			(6	)							45
Net cash provided by (used in) financing activities			1,148				(2,942	)			(789	)							(2,583	)
Cash and cash equivalents:
Increase			436				—				7				—				443
Balance at beginning of year			1,862								9								1,871
Balance at end of year		$	2,298			$	—			$	16			$	—			$	2,314

 

82

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

Condensed Consolidating Statements of Cash Flows

(in millions of dollars)

 

for the year ended December 31, 2009		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		$	(10	)		$	3,496			$	(43	)		$	—			$	3,443
Cash Provided by (Used in) Investing Activities
Consumer products
Capital expenditures							(149	)			(124	)							(273	)
Acquisition of UST, net of acquired cash											(10,244	)							(10,244	)
Changes in amounts due to/from Altria Group, Inc. and subsidiaries			(6,000	)							6,000
Other							(4	)			(27	)							(31	)
Financial services
Investment in finance assets											(9	)							(9	)
Proceeds from finance assets											793								793
Net cash used in investing activities			(6,000	)			(153	)			(3,611	)							(9,764	)
Cash Provided by (Used in) Financing Activities
Consumer products
Net repayment of short-term borrowings											(205	)							(205	)
Long-term debt issued			4,221																4,221
Long-term debt repaid							(135	)			(240	)							(375	)
Financial Services
Long-term debt repaid											(500	)							(500	)
Dividends paid on common stock			(2,693	)															(2,693	)
Issuances of common stock			89																89
Financing fees and debt issuance costs			(177	)															(177	)
Changes in amounts due to/from Altria Group, Inc. and subsidiaries			(5,227	)			423				4,804
Cash dividends received from/(paid by) subsidiaries			3,711				(3,575	)			(136	)
Other			38				(57	)			(65	)							(84	)
Net cash (used in) provided by financing activities			(38	)			(3,344	)			3,658								276
Cash and cash equivalents:
(Decrease) increase			(6,048	)			(1	)			4				—				(6,045	)
Balance at beginning of year			7,910				1				5								7,916
Balance at end of year		$	1,862			$	—			$	9			$	—			$	1,871

 

83

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Notes to Consolidated Financial Statements

 

 

 

Note 21. Quarterly Financial Data (Unaudited):

 

				2011 Quarters
(in millions, except per share data)				1st				2nd				3rd				4th
Net revenues				$	5,643			$	5,920			$	6,108			$	6,129
Gross profit				$	2,148			$	1,972			$	2,445			$	2,374
Net earnings				$	938			$	444			$	1,174			$	837
Net earnings attributable to noncontrolling interests					(1	)							(1	)			(1	)
Net earnings attributable to Altria Group, Inc.				$	937			$	444			$	1,173			$	836
Per share data:
Basic EPS attributable to Altria Group, Inc.				$	0.45			$	0.21			$	0.57			$	0.41
Diluted EPS attributable to Altria Group, Inc.				$	0.45			$	0.21			$	0.57			$	0.41
Dividends declared				$	0.38			$	0.38			$	0.41			$	0.41
Market price		- high		$	26.27			$	28.13			$	27.41			$	30.40
		- low		$	23.34			$	25.81			$	23.20			$	25.94
				2010 Quarters
(in millions, except per share data)				1st				2nd				3rd				4th
Net revenues				$	5,760			$	6,274			$	6,402			$	5,927
Gross profit				$	2,084			$	2,374			$	2,476			$	2,254
Net earnings				$	813			$	1,043			$	1,131			$	920
Net earnings attributable to noncontrolling interests									(1	)							(1	)
Net earnings attributable to Altria Group, Inc.				$	813			$	1,042			$	1,131			$	919
Per share data:
Basic EPS attributable to Altria Group, Inc.				$	0.39			$	0.50			$	0.54			$	0.44
Diluted EPS attributable to Altria Group, Inc.				$	0.39			$	0.50			$	0.54			$	0.44
Dividends declared				$	0.35			$	0.35			$	0.38			$	0.38
Market price		- high		$	20.86			$	21.91			$	24.39			$	26.22
		- low		$	19.14			$	19.20			$	19.89			$	23.66

 

84

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Altria Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

 

 

During 2011 and 2010, the following pre-tax charges or (gains) were included in net earnings attributable to Altria Group, Inc.:

 

		2011 Quarters
(in millions)		1st				2nd				3rd				4th
Asset impairment and exit costs		$	2			$	1			$	—			$	219
Implementation and integration costs							2				1				1
Tobacco and health judgments, including accrued interest							41								121
UST acquisition-related costs			4								1				1
PMCC (decrease) increase to allowance for losses											(35	)			60
Reduction to cumulative lease earnings related to the PMCC Leveraged Lease Charge							490
SABMiller special items			(32	)			57				11				46
		$	(26	)		$	591			$	(22	)		$	448
		2010 Quarters
(in millions)		1st				2nd				3rd				4th
Asset impairment and exit costs		$	7			$	21			$	3			$	5
Implementation and integration costs			33				29				24				9
Tobacco and health judgments, including accrued interest			3				16				2
UST acquisition-related costs			5				5				5				7
SABMiller special items			17				47				21				22
		$	65			$	118			$	55			$	43

As discussed in Note 15. Income Taxes, Altria Group, Inc. has recognized income tax benefits and charges in the consolidated statements of earnings during 2011 and 2010 as a result of various tax events.

 

85