Q2 2012 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2012
OR
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                     to                    
Commission File Number 1-08940
Altria Group, Inc.
(Exact name of registrant as specified in its charter)
 
 
 
Virginia
 
13-3260245
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
6601 West Broad Street, Richmond, Virginia
 
23230
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code (804) 274-2200 
 Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes   þ     No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
þ
  
Accelerated filer
  
¨
 
 
 
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
  
Smaller reporting company
  
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No   þ
At July 16, 2012, there were 2,032,833,474 shares outstanding of the registrant’s common stock, par value $0.33 1/3 per share.


Table of Contents



ALTRIA GROUP, INC.
TABLE OF CONTENTS
 
 
 
 
 
 
 
  
 
  
Page No.
PART I -
  
FINANCIAL INFORMATION
  
 
 
 
 
 
Item 1.
  
Financial Statements (Unaudited)
  
 
 
 
 
 
 
  
  
 
 
 
 
 
  

  
 
 

 
 
 
 
 
 
 
 

 
 
  

  
 
 
 
 
 
  
  
 
 
 
 
 
  
  
 
 
 
 
 
  
  
 
 
 
 
Item 2.
  
  
 
 
 
 
Item 4.
  
  
 
 
 
 
PART II -
  
OTHER INFORMATION
  
 
 
 
 
 
Item 1.
  
  
 
 
 
 
Item 1A.
  
  
 
 
 
 
Item 2.
  
  
 
 
 
 
Item 5.
 
 
 
 
 
 
 
Item 6.
  
  
 
 
 
 
Signature
  
  


- 2-
Table of Contents


PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Altria Group, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(in millions of dollars)
(Unaudited)
 
 
 
June 30, 2012
 
December 31, 2011
Assets
 
 
 
 
Consumer products
 
 
 
 
Cash and cash equivalents
 
$
1,528

 
$
3,270

Receivables
 
256

 
268

Inventories:
 

 

Leaf tobacco
 
799

 
934

Other raw materials
 
184

 
170

Work in process
 
269

 
316

Finished product
 
432

 
359

 
 
1,684

 
1,779

Deferred income taxes
 
1,207

 
1,207

Other current assets
 
468

 
607

Total current assets
 
5,143

 
7,131

Property, plant and equipment, at cost
 
4,750

 
4,728

Less accumulated depreciation
 
2,619

 
2,512

 
 
2,131

 
2,216

Goodwill
 
5,174

 
5,174

Other intangible assets, net
 
12,088

 
12,098

Investment in SABMiller
 
6,486

 
5,509

Other assets
 
472

 
1,257

Total consumer products assets
 
31,494

 
33,385

Financial services
 
 
 
 
Finance assets, net
 
3,012

 
3,559

Other assets
 
41

 
18

Total financial services assets
 
3,053

 
3,577

Total Assets
 
$
34,547

 
$
36,962

 
See notes to condensed consolidated financial statements.
Continued



- 3-
Table of Contents


Altria Group, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets (Continued)
(in millions of dollars, except share and per share data)
(Unaudited)
 
 
 
June 30, 2012
 
December 31, 2011
Liabilities
 
 
 
 
Consumer products
 
 
 
 
Current portion of long-term debt
 
$
600

 
$
600

Accounts payable
 
335

 
503

Accrued liabilities:
 

 

Marketing
 
581

 
430

Taxes, except income taxes
 
218

 
220

Employment costs
 
110

 
225

Settlement charges
 
2,184

 
3,513

Other
 
1,217

 
1,311

Dividends payable
 
836

 
841

Total current liabilities
 
6,081

 
7,643

Long-term debt
 
13,089

 
13,089

Deferred income taxes
 
5,074

 
4,751

Accrued pension costs
 
1,139

 
1,662

Accrued postretirement health care costs
 
2,367

 
2,359

Other liabilities
 
606

 
602

Total consumer products liabilities
 
28,356

 
30,106

Financial services
 
 
 
 
Deferred income taxes
 
1,764

 
2,811

Other liabilities
 
119

 
330

Total financial services liabilities
 
1,883

 
3,141

Total liabilities
 
30,239

 
33,247

Contingencies (Note 11)
 

 

Redeemable noncontrolling interest
 
33

 
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
 
5,647

 
5,674

Earnings reinvested in the business
 
24,334

 
23,583

Accumulated other comprehensive losses
 
(1,674
)
 
(1,887
)
Cost of repurchased stock
(773,116,613 shares in 2012 and 761,542,032 shares in 2011)
 
(24,969
)
 
(24,625
)
Total stockholders’ equity attributable to Altria Group, Inc.
 
4,273

 
3,680

Noncontrolling interests
 
2

 
3

Total stockholders’ equity
 
4,275

 
3,683

Total Liabilities and Stockholders’ Equity
 
$
34,547

 
$
36,962

See notes to condensed consolidated financial statements.

- 4-
Table of Contents



Altria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions of dollars, except per share data)
(Unaudited)
 
 
 
For the Six Months Ended June 30,
 
 
2012
 
2011
Net revenues
 
$
12,134

 
$
11,563

Cost of sales
 
3,878

 
3,825

Excise taxes on products
 
3,560

 
3,618

Gross profit
 
4,696

 
4,120

Marketing, administration and research costs
 
1,130

 
1,272

Asset impairment and exit costs
 
37

 
3

Amortization of intangibles
 
10

 
11

Operating income
 
3,519

 
2,834

Interest and other debt expense, net
 
586

 
572

Earnings from equity investment in SABMiller
 
(743
)
 
(344
)
Earnings before income taxes
 
3,676

 
2,606

Provision for income taxes
 
1,255

 
1,224

Net earnings
 
2,421

 
1,382

Net earnings attributable to noncontrolling interests
 
(1
)
 
(1
)
Net earnings attributable to Altria Group, Inc.
 
$
2,420

 
$
1,381

Per share data:
 
 
 
 
Basic earnings per share attributable to Altria Group, Inc.
 
$
1.19

 
$
0.66

Diluted earnings per share attributable to Altria Group, Inc.
 
$
1.19

 
$
0.66

Dividends declared
 
$
0.82

 
$
0.76



See notes to condensed consolidated financial statements.

- 5-



Altria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Earnings
(in millions of dollars, except per share data)
(Unaudited)
 
 
 
For the Three Months Ended June 30,
 
 
2012
 
2011
Net revenues
 
$
6,487

 
$
5,920

Cost of sales
 
2,086

 
2,030

Excise taxes on products
 
1,907

 
1,918

Gross profit
 
2,494

 
1,972

Marketing, administration and research costs
 
596

 
671

Asset impairment and exit costs
 
16

 
1

Amortization of intangibles
 
5

 
5

Operating income
 
1,877

 
1,295

Interest and other debt expense, net
 
293

 
294

Earnings from equity investment in SABMiller
 
(223
)
 
(155
)
Earnings before income taxes
 
1,807

 
1,156

Provision for income taxes
 
581

 
712

Net earnings
 
1,226

 
444

Net earnings attributable to noncontrolling interests
 
(1
)
 
—

Net earnings attributable to Altria Group, Inc.
 
$
1,225

 
$
444

Per share data:
 
 
 
 
Basic earnings per share attributable to Altria Group, Inc.
 
$
0.60

 
$
0.21

Diluted earnings per share attributable to Altria Group, Inc.
 
$
0.60

 
$
0.21

Dividends declared
 
$
0.41

 
$
0.38


See notes to condensed consolidated financial statements.

- 6-
Table of Contents



Altria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Comprehensive Earnings
(in millions of dollars)
(Unaudited)

 
 
For the Six Months Ended June 30,
 
 
2012
 
2011
Net earnings
 
$
2,421

 
$
1,382

Other comprehensive earnings, net of deferred income taxes:
 
 
 
 
Currency translation adjustments
 
—

 
1

Benefit plans:
 
 
 
 
Amounts reclassified to net earnings
 
61

 
64

 
 

 

SABMiller:
 
 
 
 
Ownership share of SABMiller's other comprehensive earnings before reclassifications to net earnings
 
154

 
135

Amounts reclassified to net earnings
 
(2
)
 
5

 
 
152

 
140

Other comprehensive earnings, net of deferred income taxes
 
213

 
205

 
 
 
 
 
Comprehensive earnings
 
2,634

 
1,587

Comprehensive earnings attributable to noncontrolling interests
 
(1
)
 
(1
)
Comprehensive earnings attributable to Altria Group, Inc.
 
$
2,633

 
$
1,586


See notes to condensed consolidated financial statements.


- 7-
Table of Contents



Altria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Comprehensive Earnings
(in millions of dollars)
(Unaudited)

 
 
For the Three Months Ended June 30,
 
 
2012
 
2011
Net earnings
 
$
1,226

 
$
444

Other comprehensive earnings, net of deferred income taxes:
 
 
 
 
Currency translation adjustments
 
—

 
1

Benefit plans:
 

 

Amounts reclassified to net earnings
 
39

 
32

 
 

 

SABMiller:
 

 

Ownership share of SABMiller's other comprehensive (losses) earnings before reclassifications to net earnings
 
(23
)
 
78

Amounts reclassified to net earnings
 
(5
)
 
1

 
 
(28
)
 
79

Other comprehensive earnings, net of deferred income taxes
 
11

 
112

 
 
 
 
 
Comprehensive earnings
 
1,237

 
556

Comprehensive earnings attributable to noncontrolling interests
 
(1
)
 
—

Comprehensive earnings attributable to Altria Group, Inc.
 
$
1,236

 
$
556


See notes to condensed consolidated financial statements.


- 8-
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Altria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Stockholders’ Equity
for the Year Ended December 31, 2011 and
the Six Months Ended June 30, 2012
(in millions of dollars, except per share data)
(Unaudited)
 
 
 
Attributable to Altria Group, Inc.
 
 
 
 
 
 
Common
Stock
 
Additional
Paid-in
Capital
 
Earnings
Reinvested
in the
Business
 
Accumulated
Other
Comprehensive
Losses
 
Cost of
Repurchased
Stock
 
Non-controlling
Interests

 
Total
Stockholders’
Equity
Balances, December 31, 2010
 
$
935

 
$
5,751

 
$
23,459

 
$
(1,484
)
 
$
(23,469
)
 
$
3

 
$
5,195

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings (1)
 
—

 
—

 
3,390

 
—

 
—

 
1

 
3,391

Other comprehensive losses, net of deferred income tax benefit
 
—

 
—

 
—

 
(403
)
 
—

 
—

 
(403
)
Exercise of stock options and other stock award activity
 
—

 
(77
)
 
—

 
—

 
171

 
—

 
94

Cash dividends declared ($1.58 per share)
 
—

 
—

 
(3,266
)
 
—

 
—

 
—

 
(3,266
)
Repurchases of common stock
 
—

 
—

 
—

 
—

 
(1,327
)
 
—

 
(1,327
)
Other
 
—

 
—

 
—

 
—

 
—

 
(1
)
 
(1
)
Balances, December 31, 2011
 
935

 
5,674

 
23,583

 
(1,887
)
 
(24,625
)
 
3

 
3,683

Net earnings (1)
 
—

 
—

 
2,420

 
—

 
—

 
—

 
2,420

Other comprehensive earnings, net of deferred income taxes
 
—

 
—

 
—

 
213

 
—

 
—

 
213

Exercise of stock options and other stock award activity
 
—

 
(27
)
 
—

 
—

 
16

 
—

 
(11
)
Cash dividends declared ($0.82 per share)
 
—

 
—

 
(1,669
)
 
—

 
—

 
—

 
(1,669
)
Repurchases of common stock
 
—

 
—

 
—

 
—

 
(360
)
 
—

 
(360
)
Other
 
—

 
—

 
—

 
—

 
—

 
(1
)
 
(1
)
Balances, June 30, 2012
 
$
935

 
$
5,647

 
$
24,334

 
$
(1,674
)
 
$
(24,969
)
 
$
2

 
$
4,275


(1) 
Net earnings attributable to noncontrolling interests for the six months ended June 30, 2012 and for the year ended December 31, 2011 exclude $1 million and $2 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 condensed consolidated balance sheets at June 30, 2012 and December 31, 2011, respectively. See Note 11.

See notes to condensed consolidated financial statements.


- 9-
Table of Contents




Altria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in millions of dollars)
(Unaudited)
                                            
 
 
 
For the Six Months Ended June 30,
 
 
2012
 
2011
Cash Provided by (Used In) Operating Activities
 
 
 
 
Net earnings (loss) - Consumer products
 
$
2,311

 
$
1,962

     - Financial services
 
110

 
(580
)
Net earnings
 
2,421

 
1,382

Adjustments to reconcile net earnings to operating cash flows:
 
 
 
 
Consumer products
 
 
 
 
Depreciation and amortization
 
113

 
121

Deferred income tax provision
 
299

 
132

Earnings from equity investment in SABMiller
 
(743
)
 
(344
)
Asset impairment and exit costs, net of cash paid
 
(34
)
 
(24
)
IRS payment related to LILO and SILO transactions
 
(456
)
 
—

Cash effects of changes:
 
 
 
 
Receivables, net
 
2

 
(12
)
Inventories
 
95

 
130

Accounts payable
 
(64
)
 
(94
)
Income taxes
 
(251
)
 
5

Accrued liabilities and other current assets
 
58

 
58

Accrued settlement charges
 
(1,329
)
 
(1,398
)
Pension plan contributions
 
(514
)
 
(209
)
Pension provisions and postretirement, net
 
85

 
122

Other
 
90

 
121

Financial services
 
 
 
 
Deferred income tax benefit
 
(1,270
)
 
(529
)
PMCC leveraged lease charges
 
7

 
490

Decrease to allowance for losses
 
(10
)
 
—

Other liabilities (income taxes)
 
1,437

 
505

Other
 
(21
)
 
23

Net cash (used in) provided by operating activities
 
(85
)
 
479

See notes to condensed consolidated financial statements.
Continued













- 10-
Table of Contents


Altria Group, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Continued)
(in millions of dollars)
(Unaudited)
                                            
 
 
 
For the Six Months Ended June 30,
 
 
2012
 
2011
Cash Provided by (Used In) Investing Activities
 
 
 
 
Consumer products
 
 
 
 
Capital expenditures
 
$
(39
)
 
$
(40
)
Other
 
(3
)
 
1

Financial services
 
 
 
 
Proceeds from finance assets
 
552

 
129

Net cash provided by investing activities
 
510

 
90

Cash Provided by (Used In) Financing Activities
 
 
 
 
Consumer products
 
 
 
 
Long-term debt issued
 
—

 
1,494

Repurchases of common stock
 
(360
)
 
(575
)
Dividends paid on common stock
 
(1,674
)
 
(1,589
)
Issuances of common stock
 
—

 
29

Financing fees and debt issuance costs
 
—

 
(23
)
Other
 
(133
)
 
(155
)
Net cash used in financing activities
 
(2,167
)
 
(819
)
Cash and cash equivalents:
 
 
 
 
Decrease
 
(1,742
)
 
(250
)
Balance at beginning of period
 
3,270

 
2,314

Balance at end of period
 
$
1,528

 
$
2,064

See notes to condensed consolidated financial statements.

- 11-
Table of Contents




Note 1. Background and Basis of Presentation:

Background

At June 30, 2012, Altria Group, Inc.'s direct and indirect wholly-owned subsidiaries included Philip Morris USA Inc. (“PM USA”), which is engaged in the manufacture and sale of cigarettes and certain smokeless products in the United States; John Middleton Co. ("Middleton"), which is engaged in the manufacture and sale of machine-made large cigars and pipe tobacco, and is a wholly-owned subsidiary of PM USA; and UST LLC (“UST”), which through its direct and indirect wholly-owned subsidiaries including U.S. Smokeless Tobacco Company LLC (“USSTC”) and Ste. Michelle Wine Estates Ltd. (“Ste. Michelle”), is engaged in the manufacture and sale of smokeless products and wine. Philip Morris Capital Corporation (“PMCC”), another wholly-owned subsidiary of Altria Group, Inc., maintains a portfolio of leveraged and direct finance leases. In addition, Altria Group, Inc. held an approximate 27.0% economic and voting interest in SABMiller plc (“SABMiller”) at June 30, 2012, which is accounted for under the equity method of accounting. Altria Group, Inc.'s access to the operating cash flows of its wholly-owned subsidiaries consists of cash received from the payment of dividends and distributions, and the payment of interest on intercompany loans by its subsidiaries. In addition, Altria Group, Inc. receives cash dividends on its interest in SABMiller if and when SABMiller pays such dividends. At June 30, 2012, Altria Group, Inc.'s principal wholly-owned subsidiaries were not limited by long-term debt or other agreements in their ability to pay cash dividends or make other distributions with respect to their common stock.

Share Repurchases

In October 2011, Altria Group, Inc.'s Board of Directors authorized a $1.0 billion share repurchase program, which Altria Group, Inc. intends to complete by the end of 2012. During the six and three months ended June 30, 2012, Altria Group, Inc. repurchased 11.9 million shares (aggregate cost of approximately $360 million, and $30.16 average price per share) and 2.0 million shares (aggregate cost of approximately $66 million, and $32.37 average price per share), respectively. As of June 30, 2012, Altria Group, Inc. had repurchased a total of 23.7 million shares of its common stock under this program at an aggregate cost of approximately $688 million, and an average price of $29.01 per share. The timing of share repurchases under this program depends upon marketplace conditions and other factors, and the program remains subject to the discretion of Altria Group, Inc.'s Board of Directors.

Basis of Presentation

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

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

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

During the second quarter of 2012, Altria Group, Inc. determined that it had not recorded in its financial statements for the three months ended March 31, 2012, its share of non-cash gains from its equity investment in SABMiller, relating to SABMiller's strategic alliance transactions with Anadolu Efes and Castel that were closed during the first quarter of 2012. Because Altria Group, Inc. did not record these gains, it understated by $342 million, $222 million and $0.11 earnings from equity investment in SABMiller, net earnings/comprehensive earnings, and diluted earnings per share attributable to Altria Group, Inc., respectively, for the three months ended March 31, 2012. Additionally, Altria Group, Inc. understated its investment in SABMiller, long-term liability for deferred income taxes and total stockholders' equity by $342 million, $120 million and $222 million, respectively, at March 31, 2012. There was no impact on net cash flows from operating, investing or financing activities for the three months ended March 31, 2012. Altria Group, Inc. assessed the materiality of

- 12-
Table of Contents
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

these understatements in accordance with the Securities and Exchange Commission's (“SEC”) Staff Accounting Bulletin No. 99 “Materiality” and determined that the impact was not material to Altria Group, Inc.'s financial statements as of and for the three months ended March 31, 2012. Accordingly, Altria Group, Inc. has determined that it is appropriate to revise its first quarter 2012 financial statements and has reflected this revision in the financial statements as of and for the six months ended June 30, 2012. Financial results for the three months ended March 31, 2012 reported in future filings will reflect this revision.

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

Effective January 1, 2012, Altria Group, Inc. adopted new authoritative guidance that eliminated the option of presenting components of other comprehensive earnings as part of the statement of stockholders' equity. With the adoption of this guidance, Altria Group, Inc. is reporting other comprehensive earnings in separate statements immediately following the statements of earnings.


Note 2. Asset Impairment, Exit, Implementation and Integration Costs:

Pre-tax asset impairment, exit and implementation costs for the six and three months ended June 30, 2012 consisted of the following:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For The Six Months Ended
June 30, 2012
 
For The Three Months Ended
June 30, 2012
 
 
Asset Impairment and Exit Costs
 
Implementation (Gain) Costs
 
Total
 
Asset Impairment and Exit Costs
 
Implementation Costs
 
Total
 
 
(in millions)
Smokeable products
 
$
23

 
$
(12
)
 
$
11

 
$
16


$
9

 
$
25

Smokeless products
 
14

 
5

 
19

 
—


—

 
—

General corporate
 
—

 
(1
)
 
(1
)
 
—


—

 
—

Total
 
$
37

 
$
(8
)
 
$
29

 
$
16

 
$
9

 
$
25


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

For the six and three months ended June 30, 2011, total pre-tax asset impairment and exit costs were $3 million and $1 million, respectively, all of which were reported in the smokeable products segment. In addition, total pre-tax integration costs of $2 million were reported in the smokeless products segment for both the six and three months ended June 30, 2011. There were no implementation costs incurred during the six months ended June 30, 2011.
The movement in the severance liability and details of asset impairment and exit costs for Altria Group, Inc. for the six months ended June 30, 2012 was as follows:

- 13-
Table of Contents
Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 
 
 
Severance
 
Other
 
Total
 
 
(in millions)
Severance liability balance, December 31, 2011
 
$
156

 
$
—

 
$
156

      Charges
 
—

 
37

 
37

      Cash spent
 
(59
)
 
(12
)
 
(71
)
      Other
 
—

 
(25
)
 
(25
)
Severance liability balance, June 30, 2012
 
$
97

 
$
—

 
$
97


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

Implementation (gain) costs of ($8) million shown in the table above were recorded on Altria Group, Inc.'s condensed consolidated statement of earnings for the six months ended June 30, 2012, as follows: a net gain of $16 million, which included a $26 million curtailment gain related to amendments made to an Altria Group, Inc. postretirement benefit plan, was included in marketing, administration and research costs; and other costs of $8 million were included in cost of sales. For the three months ended June 30, 2012, implementation costs of $9 million shown in the table above were recorded in marketing, administration and research costs on Altria Group, Inc.'s condensed consolidated statement of earnings.

Total pre-tax charges, net, incurred since the inception of this program through June 30, 2012 were $253 million. Cash payments related to this program of $73 million and $41 million were made during the six and three months ended June 30, 2012, respectively, for total cash payments of $82 million since inception.

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


Note 3. Benefit Plans:

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

Components of Net Periodic Benefit Cost

Net periodic pension cost consisted of the following:
 

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Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 
 
For the Six Months Ended June 30,
 
For the Three Months Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(in millions)
Service cost
 
$
40

 
$
38

 
$
20

 
$
19

Interest cost
 
172

 
175

 
86

 
88

Expected return on plan assets
 
(221
)
 
(211
)
 
(110
)
 
(105
)
Amortization:
 
 
 
 
 
 
 
 
Net loss
 
112

 
86

 
56

 
43

Prior service cost
 
5

 
7

 
2

 
3

Net periodic pension cost
 
$
108

 
$
95

 
$
54

 
$
48


Employer Contributions

Altria Group, Inc. makes contributions to the extent that they are tax deductible and to pay benefits that relate to plans for salaried employees that cannot be funded under Internal Revenue Service (“IRS”) regulations. On January 3, 2012, Altria Group, Inc. made a voluntary $500 million contribution to its pension plans. Additional employer contributions of $14 million were made to Altria Group, Inc.'s pension plans during the six months ended June 30, 2012. Currently, Altria Group, Inc. anticipates making additional employer contributions to its pension plans of approximately $20 million to $40 million during the remainder of 2012, based on current tax law. However, this estimate is subject to change as a result of changes in tax and other benefit laws, as well as asset performance significantly above or below the assumed long-term rate of return on pension assets, or changes in interest rates.

Postretirement Benefit Plans

Net postretirement health care costs consisted of the following:

 
 
For the Six Months Ended June 30,
 
For the Three Months Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(in millions)
Service cost
 
$
11

 
$
17

 
$
6

 
$
8

Interest cost
 
60

 
69

 
30

 
35

Amortization:
 
 
 
 
 
 
 
 
Net loss
 
24

 
19

 
12

 
10

Prior service credit
 
(23
)
 
(11
)
 
(12
)
 
(6
)
Curtailment gain
 
(26
)
 
—

 
—

 
—

Net postretirement health care costs
 
$
46

 
$
94

 
$
36

 
$
47


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

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Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)



Note 4. Earnings from Equity Investment in SABMiller:
Pre-tax earnings from Altria Group, Inc.’s equity investment in SABMiller consisted of the following:
 
 
 
For the Six Months Ended
June 30,
 
For the Three Months Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(in millions)
Equity earnings
 
$
726

 
$
333

 
$
218

 
$
148

Gains resulting from issuances of common stock by SABMiller
 
17

 
11

 
5

 
7

 
 
$
743

 
$
344

 
$
223

 
$
155


Altria Group, Inc.'s equity earnings for the six months ended June 30, 2012, included its share of non-cash gains resulting from SABMiller's strategic alliance transactions with Anadolu Efes and Castel that were closed during the first quarter of 2012. For further discussion, see Note 1. Background and Basis of Presentation.
Note 5. Earnings Per Share:
Basic and diluted earnings per share (“EPS”) were calculated using the following:
 
 
 
For the Six Months Ended
June 30,
 
For the Three Months Ended
June 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(in millions)
Net earnings attributable to Altria Group, Inc.
 
$
2,420

 
$
1,381

 
$
1,225

 
$
444

Less: Distributed and undistributed earnings attributable to unvested restricted and deferred shares
 
(8
)
 
(5
)
 
(4
)
 
(1
)
Earnings for basic and diluted EPS
 
$
2,412

 
$
1,376

 
$
1,221

 
$
443

 
 
 
 
 
 
 
 
 
Weighted-average shares for basic and diluted EPS
 
2,030

 
2,080

 
2,027

 
2,076

As of February 29, 2012, there were no stock options outstanding. For the six and three months ended June 30, 2012 and 2011 computations, there were no antidilutive stock options.


Note 6. Other Comprehensive Earnings/Losses:
The following table sets forth the changes in each component of accumulated other comprehensive losses, net of deferred income taxes, attributable to Altria Group, Inc.:
 
 
 
Currency
Translation
Adjustments
 
Benefit Plans
 
SABMiller
 
Accumulated
Other
Comprehensive
Losses
 
 
(in millions)
Balances, December 31, 2010
 
$
4

 
$
(1,811
)
 
$
323

 
$
(1,484
)
Period change
 
(2
)
 
(251
)
 
(150
)
 
(403
)
Balances, December 31, 2011
 
2

 
(2,062
)
 
173

 
(1,887
)
Period change
 
—

 
61

 
152

 
213

Balances, June 30, 2012
 
$
2

 
$
(2,001
)
 
$
325

 
$
(1,674
)


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Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The following table sets forth deferred income tax expense (benefit) for the components of other comprehensive earnings for the six and three months ended June 30, 2012 and 2011.
 
 
Currency
Translation
Adjustments
 
Benefit Plans
 
SABMiller
 
Total
 
 
(in millions)
 
 
 
 
 
 
 
 
 
For the six months ended June 30, 2012
 
$
—

 
$
41

 
$
81

 
$
122

For the six months ended June 30, 2011
 
$
—

 
$
42

 
$
75

 
$
117

 
 
 
 
 
 
 
 
 
For the three months ended June 30, 2012
 
$
—

 
$
26

 
$
(16
)
 
$
10

For the three months ended June 30, 2011
 
$
—

 
$
21

 
$
43

 
$
64




Note 7. Segment Reporting:

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

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

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

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Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Segment data were as follows: 
 
 
For the Six Months Ended June 30,
 
For the Three Months Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
 
 
(in millions)
Net revenues:
 
 
 
 
 
 
 
 
Smokeable products
 
$
11,003

 
$
11,001

 
$
5,903

 
$
5,858

Smokeless products
 
806

 
783

 
426

 
404

Wine
 
241

 
217

 
128

 
116

Financial services
 
84

 
(438
)
 
30

 
(458
)
Net revenues
 
$
12,134

 
$
11,563

 
$
6,487

 
$
5,920

Earnings before income taxes:
 
 
 
 
 
 
 
 
Operating companies income (loss):
 
 
 
 
 
 
 
 
Smokeable products
 
$
3,079

 
$
2,952

 
$
1,640

 
$
1,583

Smokeless products
 
432

 
415

 
240

 
222

Wine
 
37

 
31

 
22

 
19

Financial services
 
87

 
(442
)
 
35

 
(463
)
Amortization of intangibles
 
(10
)
 
(11
)
 
(5
)
 
(5
)
General corporate expenses
 
(106
)
 
(111
)
 
(55
)
 
(61
)
Operating income
 
3,519

 
2,834

 
1,877

 
1,295

Interest and other debt expense, net
 
(586
)
 
(572
)
 
(293
)
 
(294
)
Earnings from equity investment in SABMiller
 
743

 
344

 
223

 
155

Earnings before income taxes
 
$
3,676

 
$
2,606

 
$
1,807

 
$
1,156


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

PMCC Leveraged Lease Benefit / Charge - During the second quarter of 2012, Altria Group, Inc. recorded a one-time net earnings benefit of $68 million as a result of the execution of a closing agreement (the “Closing Agreement”) with the IRS that conclusively resolved the federal income tax treatment for all prior and future tax years of certain leveraged lease transactions entered into by PMCC. Included in this net benefit was a pre-tax charge of $7 million that was recorded as a decrease to PMCC's net revenues and operating companies income. During the second quarter of 2011, Altria Group, Inc. recorded a charge of $627 million related to the federal income tax treatment of these transactions (the "PMCC Leveraged Lease Charge"). Included in this charge was 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 10. Income Taxes and Note 11. Contingencies for further discussion of this matter).

PMCC Allowance for Losses - During the second quarter of 2012, PMCC decreased its allowance for losses by $10 million, based on management's assessment of the credit quality and size of PMCC's leasing portfolio. (See Note 8. Finance Assets, net).

Tobacco and Health Judgments - For the six and three months ended June 30, 2012 and 2011, Altria Group, Inc. recorded net pre-tax charges of $1 million and $36 million (excluding accrued interest), respectively, related to certain tobacco and health judgments. These charges are reflected in the smokeable products segment. See Note 11. Contingencies.

Asset Impairment, Exit, Implementation and Integration Costs - See Note 2. Asset Impairment, Exit, Implementation and Integration Costs for a breakdown of these costs by segment.

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Notes to Condensed Consolidated Financial Statements
(Unaudited)


Note 8. Finance Assets, net:

At June 30, 2012, finance assets, net, of $3,012 million were comprised of investments in finance leases of $3,171 million and an other receivable of $29 million, reduced by the allowance for losses of $188 million. At December 31, 2011, finance assets, net, of $3,559 million were comprised of investments in finance leases of $3,786 million, reduced by the allowance for losses of $227 million.

PMCC assesses the adequacy of its allowance for losses relative to the credit risk of its leasing portfolio on an ongoing basis. During the second quarter of 2012, PMCC determined that its allowance for losses exceeded the amount required based on its assessment of the credit quality and size of the leasing portfolio. As a result, the allowance for losses was reduced by $10 million, which was recorded as income during the second quarter of 2012. PMCC believes that, as of June 30, 2012, the allowance for losses of $188 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 six months ended June 30, 2012, and 2011 was as follows:
 
 
For the Six Months Ended
June 30,
 
 
2012
 
2011
 
 
(in millions)
Balance at beginning of the year
 
$
227

 
$
202

Decrease to allowance
 
(10
)
 
—

Amounts written-off
 
(29
)
 
—

Balance at June 30
 
$
188

 
$
202


PMCC had 28 aircraft on lease to American Airlines, Inc. (“American”), on November 29, 2011 when American filed for bankruptcy. As of the date of the bankruptcy filing, PMCC stopped recording income on its $140 million investment in finance leases from American. In the first quarter of 2012, American filed a motion to reject the leases for nine of the 28 aircraft under lease, which resulted in a $23 million write-off of the related investment in finance lease balance against PMCC's allowance for losses. Deferred taxes of approximately $12 million is subject to acceleration upon foreclosure of the leases rejected in the first quarter of 2012. During the second quarter of 2012, as a result of the early termination of one aircraft lease, PMCC wrote-off an additional $6 million against PMCC's allowance for losses. On July 19, 2012, the bankruptcy court approved an agreement for PMCC to sell its interest in 10 aircraft leases back to American, which will result in a $60 million write-off of the related investment in finance lease balance against PMCC's allowance for losses in the third quarter of 2012. As a result of the sale of these leases, deferred taxes of $10 million will be accelerated in the third quarter of 2012. The remaining leases could be rejected or restructured, which would result in a write-off of the related investment in finance lease balance against PMCC's allowance for losses.

With the exception of American, all PMCC lessees were current on their lease payment obligations as of June 30, 2012.
The credit quality of PMCC’s investments in finance assets as assigned by Standard & Poor’s Ratings Services (“Standard & Poor’s”) and Moody’s Investors Service, Inc. (“Moody’s”) at June 30, 2012 and December 31, 2011 was as follows:

 
 
June 30, 2012
 
December 31, 2011
 
 
(in millions)
Credit Rating by Standard & Poor’s/Moody’s:
 
 
 
 
“AAA/Aaa” to “A-/A3”
 
$
1,283

 
$
1,570

“BBB+/Baa1” to “BBB-/Baa3”
 
985

 
1,080

“BB+/Ba1” and Lower
 
932

 
1,136

Total
 
$
3,200

 
$
3,786


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Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)


On May 22, 2012, Altria Group, Inc. entered into the Closing Agreement with the IRS that conclusively resolved the federal income tax treatment for all prior and future tax years of certain leveraged lease transactions entered into by PMCC. As a result of the Closing Agreement, Altria Group, Inc. recorded a one-time net earnings benefit of $68 million during the second quarter of 2012 due primarily to lower than estimated interest on tax underpayments.

During the second quarter of 2011, Altria Group, Inc. recorded the PMCC Leveraged Lease Charge. Approximately 50% of the charge ($315 million) represented 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 represented a permanent charge for interest on tax underpayments.

For the six and three months ended, June 30, 2012 and 2011, the PMCC leveraged lease (benefit) charge was recorded in Altria Group, Inc.'s condensed consolidated statements of earnings as follows:

 
 
For the Six and Three Months Ended
June 30, 2012
 
For the Six and Three Months Ended
June 30, 2011
 
 
Net Revenues
 
Benefit for Income Taxes
 
Total
 
Net Revenues
 
(Benefit) Provision for Income Taxes
 
Total
 
 
(in millions)
Reduction to cumulative lease earnings
 
$
7

 
$
(2
)
 
$
5

 
$
490

 
$
(175
)
 
$
315

Interest on tax underpayments
 
—

 
(73
)
 
(73
)
 
—

 
312

 
312

Total
 
$
7

 
$
(75
)
 
$
(68
)
 
$
490

 
$
137

 
$
627


See Note 10. Income Taxes and Note 11. Contingencies for a further discussion of the Closing Agreement and the PMCC leveraged lease benefit/charge.
Note 9. Debt:
At June 30, 2012 and December 31, 2011, Altria Group, Inc. had no short-term borrowings.

In July 2012, UST senior notes of $600 million matured and were repaid.

Altria Group, Inc.'s estimate of the fair value of its debt is based on observable market information derived from a third party pricing source and is classified in level 2 of the fair value hierarchy. The aggregate fair value of Altria Group, Inc.'s total long-term debt at June 30, 2012 and December 31, 2011, was $18.2 billion and $17.7 billion, respectively, as compared with its carrying value of $13.7 billion for each period.


Note 10. Income Taxes:

The income tax rate of 34.1% for the six months ended June 30, 2012 decreased 12.9 percentage points from 47.0% for the six months ended June 30, 2011. The income tax rate of 32.2% for the three months ended June 30, 2012 decreased 29.4 percentage points from 61.6% for the three months ended June 30, 2011. The decreases in the income tax rates were due primarily to a $312 million charge that primarily represents interest on tax underpayments associated with the PMCC Leveraged Lease Charge which was recorded during the second quarter of 2011. The decreases in the income tax rates were further impacted by a $73 million interest benefit, recorded during the second quarter of 2012 resulting primarily from lower than estimated interest on tax underpayments related to the Closing Agreement with the IRS.

As a result of the Closing Agreement, on June 15, 2012, Altria Group, Inc. paid $456 million in federal income taxes and related estimated interest on tax underpayments. Altria Group, Inc. also expects to pay approximately $50 million in state taxes and related estimated interest during the second half of 2012. The tax component of these payments represents an acceleration of federal and state income taxes that Altria Group, Inc. would have otherwise paid over the lease terms of these transactions.


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Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

See Note 8. Finance Assets, net and Note 11. Contingencies for further discussion of the Closing Agreement and the PMCC leveraged lease benefit/charge.


Note 11. 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 remains a risk that such relief may not be obtainable in all cases. This risk has been substantially reduced given that 44 states and Puerto Rico now limit the dollar amount of bonds or require no bond at all. As discussed below, however, tobacco litigation plaintiffs have challenged the constitutionality of Florida's bond cap statute in several cases and plaintiffs may challenge state bond cap statutes in other jurisdictions as well. Such challenges may include the applicability of state bond caps in federal court. Although we cannot predict the outcome of such challenges, it is possible that the consolidated results of operations, cash flows or financial position of Altria Group, Inc., or one or more of its subsidiaries, could be materially affected in a particular fiscal quarter or fiscal year by an unfavorable outcome of one or more such challenges.

Altria Group, Inc. and its subsidiaries record provisions in the condensed consolidated financial statements for pending litigation when they determine that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. At the present time, while it is reasonably possible that an unfavorable outcome in a case may occur, except as discussed elsewhere in this Note 11. Contingencies: (i) management has concluded that it is not probable that a loss has been incurred in any of the pending tobacco-related cases; (ii) management is unable to estimate the possible loss or range of loss that could result from an unfavorable outcome in any of the pending tobacco-related cases; and (iii) accordingly, management has not provided any amounts in the condensed consolidated financial statements for unfavorable outcomes, if any. Legal defense costs are expensed as incurred.

Altria Group, Inc. and its subsidiaries have achieved substantial success in managing litigation. Nevertheless, litigation is subject to uncertainty and significant challenges remain. It is possible that the consolidated results of operations, cash flows or financial position of Altria Group, Inc., or one or more of its subsidiaries, could be materially affected in a particular fiscal quarter or fiscal year by an unfavorable outcome or settlement of certain pending litigation. Altria Group, Inc. and each of its subsidiaries named as a defendant believe, and each has been so advised by counsel handling the respective cases, that it has valid defenses to the litigation pending against it, as well as valid bases for appeal of adverse verdicts. Each of the companies has defended, and will continue to defend, vigorously against litigation challenges. However, Altria Group, Inc. and its subsidiaries may enter into settlement discussions in particular cases if they believe it is in the best interests of Altria Group, Inc. to do so.
 
Overview of Altria Group, Inc. and/or PM USA Tobacco-Related Litigation
Types and Number of Cases
Claims related to tobacco products generally fall within the following categories: (i) smoking and health cases alleging

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Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

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) 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 July 23, 2012, July 25, 2011 and July 26, 2010.

Type of Case
Number of Cases
Pending as of
July 23, 2012
Number of Cases
Pending as of
July 25, 2011
Number of Cases
Pending as of
July 26, 2010
Individual Smoking and Health Cases (1)
78
81
83
Smoking and Health Class Actions and Aggregated Claims Litigation (2)
7
8
9
Health Care Cost Recovery Actions
1
2
3
"Lights/Ultra Lights" Class Actions
16
19
29
Tobacco Price Cases
1
1
2

(1) Does not include 2,574 cases brought by flight attendants seeking compensatory damages for personal injuries allegedly caused by exposure to environmental tobacco smoke ("ETS"). The flight attendants allege that they are members of an ETS smoking and health class action in Florida, which was settled in 1997 (Broin). The terms of the court-approved settlement in that case allow class members to file individual lawsuits seeking compensatory damages, but prohibit them from seeking punitive damages. Also, does not include approximately 6,547 individual smoking and health cases (3,294 state court cases and 3,253 federal court cases) brought by or on behalf of approximately 7,749 plaintiffs in Florida (4,497 state court plaintiffs and 3,252 federal court plaintiffs) following the decertification of the Engle case discussed below. It is possible that some of these cases are duplicates and that additional cases have been filed but not yet recorded on the courts' dockets.

(2) Includes as one case the 600 civil actions (of which 346 are actions against PM USA) that are to be tried in a single proceeding in West Virginia (In re: Tobacco Litigation). The West Virginia Supreme Court of Appeals has ruled that the United States Constitution does not preclude a trial in two phases in this case. Under the current trial plan, issues related to defendants' conduct and whether punitive damages are permissible will be tried in the first phase. The second phase would consist of individual trials to determine liability, if any, as well as compensatory and punitive damages, if any. Trial in the case began in October 2011, but ended in a mistrial in November 2011. The court has scheduled trial for April 15, 2013.

International Tobacco-Related Cases

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

Pending and Upcoming Tobacco-Related Trials

As of July 23, 2012, 16 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

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Altria Group, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)

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

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

After exhausting all appeals in those cases resulting in adverse verdicts (Engle progeny and non-Engle progeny), PM USA has paid judgments (and related costs and fees) totaling approximately $242 million and interest totaling approximately $139 million as of July 23, 2012.

Security for Judgments
 
To obtain stays of judgments pending current appeals, as of June 30, 2012, PM USA has posted various forms of security totaling approximately $37 million, the majority of which has been collateralized with cash deposits that are included in other assets on the condensed consolidated balance sheets.

Smoking and Health Litigation

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

Non-Engle Progeny Trial Results

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

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


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Bullock: In October 2002, a California jury awarded against PM USA $850,000 in compensatory damages and $28 billion in punitive damages. In December 2002, the trial court reduced the punitive damages award to $28 million. After a series of appeals, the California Court of Appeal in 2008 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 2009, the jury returned a verdict and the trial court entered judgment, awarding plaintiffs $13.8 million in punitive damages, plus costs. After further appeals, which were denied, PM USA recorded in the fourth quarter of 2011 a pre-tax provision of $14 million related to damages and costs and $3 million related to interest. In March 2012, PM USA paid an amount of approximately $19.1 million in satisfaction of the judgment and associated costs and interest. This litigation has concluded.

Schwarz: In March 2002, an Oregon jury awarded against PM USA $168,500 in compensatory damages and $150 million in punitive damages. In May 2002, the trial court reduced the punitive damages award to $100 million. In 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 March 2011, PM USA filed a claim against the plaintiff for its costs and disbursements on appeal, plus interest. Trial on the amount of punitive damages began in January 2012. In February 2012, the jury awarded plaintiff $25 million in punitive damages. In March 2012, PM USA filed motions to set aside the verdict, for a new trial or, in the alternative, for a remittitur. The trial court denied these motions on May 17, 2012. PM USA intends to appeal.

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. After a series of appeals, PM USA in 2009 paid $61.1 million to the plaintiff, representing the compensatory damages award, forty percent of the punitive damages award and accrued interest. Upon the conclusion of further litigation concerning the remaining sixty percent share of punitive damages, PM USA in the fourth quarter of 2011 recorded a provision of approximately $48 million related to damages and costs and $54 million related to interest. In January 2012, PM USA paid an amount of approximately $102 million in satisfaction of the judgment and associated costs and interest. This litigation has concluded.

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

Engle Class Action

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

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

In July 2006, the Florida Supreme Court ordered that the punitive damages award be vacated, that the class approved by the trial court be decertified, and that members of the decertified class could file individual actions against defendants within one year of issuance of the mandate. The court further declared the following Phase I findings are entitled to res judicata effect in such individual actions brought within one year of the issuance of the mandate: (i) that smoking causes various diseases; (ii) that nicotine in cigarettes is addictive; (iii) that defendants' cigarettes were defective and unreasonably dangerous; (iv) that defendants concealed or omitted material information not otherwise known or available knowing that the material was false or misleading or failed to disclose a material fact concerning the health effects or addictive nature of

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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.

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 July 23, 2012, approximately 6,547 cases (3,294 state court cases and 3,253 federal court cases) were pending against PM USA or Altria Group, Inc. asserting individual claims by or on behalf of approximately 7,749 plaintiffs, (4,497 state court plaintiffs and 3,252 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

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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.

After the remand of B. Brown, the Eleventh Circuit's ruling on Florida state law was superseded by state appellate rulings (discussed below), which include Martin, an Engle-progeny case against R.J. Reynolds Tobacco Company ("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. 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. Martin and J. Brown are discussed in more detail below.

Following Martin and J. Brown, in the Waggoner case, the United States District Court for the Middle District of Florida (Jacksonville) ruled in December 2011 that application of the Engle findings to establish the wrongful conduct elements of plaintiffs' claims consistent with Martin or J. Brown did not violate defendants' due process rights.  The court ruled, however, that plaintiffs must establish legal causation to establish liability.  With respect to punitive damages, the district court held that plaintiffs could rely on the findings in support of their punitive damages claims but that in addition plaintiffs must demonstrate specific conduct by specific defendants, independent of the Engle findings, that satisfies the standards for awards of punitive damages.  PM USA and the other defendants sought appellate review of the due process ruling. In February 2012, the district court denied the motion for interlocutory appeal, but did apply the ruling to all active pending federal Engle progeny cases. As a result, the ruling can be appealed after an adverse verdict.
 
Engle progeny cases pending in the federal district courts in the Middle District of Florida asserting individual claims by or on behalf of approximately 3,200 plaintiffs remain stayed. There are currently 25 active cases pending in federal court.

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. Defendants have filed a motion to dismiss the appeal as moot because R.J. Reynolds has paid the judgment in Hall. Argument is set for September 7, 2012.

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

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

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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 2012 in which verdicts were returned in favor of plaintiffs.
Date
Plaintiff
Verdict
Post-Trial Developments
May 2012
Calloway
On May 8, 2012, a Broward County jury returned a verdict in favor of plaintiff and against PM USA, R.J. Reynolds, Lorillard Tobacco Company and Liggett Group. The jury awarded approximately $21 million in compensatory damages and allocated 25% of the fault against PM USA but the trial court ruled that it will not apply the comparative fault allocations because the jury found against each defendant on the intentional tort claims. The jury also awarded approximately $17 million in punitive damages against PM USA, approximately $17 million in punitive damages against R.J. Reynolds, approximately $13 million in punitive damages against Lorillard Tobacco Company and approximately $8 million in punitive damages against Liggett Group.
The trial court has not yet entered final judgment. On May 18, May 29 and June 11, 2012, the defendants filed motions to set aside the verdict and for a new trial.
 
 
 
 
January 2012
Hallgren
A Highland County jury returned a verdict in favor of plaintiff and against PM USA and R.J. Reynolds. The jury awarded approximately $2 million in compensatory damages and allocated 25% of the fault to PM USA (an amount of approximately $500,000). The jury also awarded $750,000 in punitive damages against each of the defendants.
The trial court entered final judgment in March 2012. On April 30, 2012, PM USA posted a bond in an amount of approximately $1.25 million. On May 4, 2012, the defendants filed a notice of appeal to the Florida Second District Court of Appeal.
 
 
 
 
July 2011
Weingart
A Palm Beach County jury returned a verdict in the amount of zero damages and allocated 3% of the fault to each of the defendants (PM USA, R.J. Reynolds and Lorillard Tobacco Company).
In September 2011, the trial court granted plaintiff's motion for additur or a new trial, concluding that an additur of $150,000 is required for plaintiff's pain and suffering.  The trial court entered final judgment and, since PM USA was allocated 3% of the fault, its portion of the damages was $4,500. PM USA filed its notice of appeal and posted bonds in an aggregate amount of $48,000.
 
 
 
 

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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 trial court entered final judgment. In October 2011, the trial court granted the defendants' motion for remittitur, reducing the punitive damages award against PM USA to $2.7 million, and denied defendants' remaining post-trial motions. PM USA filed a notice of appeal and posted a bond in the amount of $1.25 million in November 2011.
 
 
 
 
April 2011
Tullo
A Palm Beach County jury returned a verdict in favor of plaintiff and against PM USA, Lorillard Tobacco Company and Liggett Group. The jury awarded a total of $4.5 million in compensatory damages and allocated 45% of the fault to PM USA (an amount of $2,025,000).
In April 2011, the trial court entered final judgment. In July 2011, PM USA filed its notice of appeal and posted a $2 million bond.
 
 
 
 
February 2011
Huish
An Alachua County jury returned a verdict in favor of plaintiff and against PM USA. The jury awarded $750,000 in compensatory damages and allocated 25% of the fault to PM USA (an amount of $187,500). The jury also awarded $1.5 million in punitive damages against PM USA.
In March 2011, the trial court entered final judgment. In May 2011, PM USA filed its notice of appeal and posted a $1.7 million appeal bond. In March 2012, the Florida First District Court of Appeal affirmed per curiam the trial court's decision without issuing an opinion. In April 2012, PM USA filed a motion to extend the rehearing deadline and to stay the issuance of the mandate, which motion was denied on April 30, 2012. In the second quarter of 2012, PM USA recorded a provision on its condensed consolidated balance sheet of approximately $2.5 million. On May 29, 2012, PM USA requested that the Florida First District Court of Appeal recall the mandate issued in the case and stay the proceedings pending the Florida Supreme Court's disposition of Douglas, which motion was denied on July 11, 2012. In July 2012, PM USA paid an amount of $2.5 million in satisfaction of the judgment and associated costs.
 
 
 
 
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.
 
 
 
 

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Date
Plaintiff
Verdict
Post-Trial Developments
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. PM USA filed its notice of appeal and posted a $1.2 million appeal bond. Argument on the merits of the appeal was heard on June 12, 2012. On June 20, 2012, the Florida Fourth District Court of Appeal affirmed per curiam the trial court's decision without issuing an opinion. On July 5, 2012, the defendants filed a motion requesting that the trial court add a citation to its per curiam affirmance so that defendants can seek review of the decision in the Florida Supreme Court. Alternatively, the motion requests that the trial court stay the proceeding pending the Florida Supreme Court's disposition of Douglas.
 
 
 
 
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. Argument on the merits of the appeal was heard on June 19, 2012.
 
 
 
 
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. Argument on the merits of the appeal was heard on May 9, 2012.
 
 
 
 

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Date
Plaintiff
Verdict
Post-Trial Developments
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. In March 2012, the Florida Second District Court of Appeal issued a decision affirming the judgment and upholding the use of the Engle jury findings but certified to the Florida Supreme Court the question of whether granting res judicata effect to the Engle jury findings violates defendants' federal due process rights. In April 2012, the defendants filed a notice to invoke discretionary jurisdiction with the Florida Supreme Court. On May 15, 2012, the Florida Supreme Court accepted jurisdiction of the case. Argument is scheduled for September 6, 2012.
 
 
 
 
November 2009
Naugle
A Broward County jury returned a verdict in favor of the plaintiff and against PM USA. The jury awarded approximately $56.6 million in compensatory damages and $244 million in punitive damages. The jury allocated 90% of the fault to PM USA.
In March 2010, the trial court entered final judgment reflecting a reduced award of approximately $13 million in compensatory damages and $26 million in punitive damages. In April 2010, PM USA filed its notice of appeal and posted a $5 million appeal bond. In August 2010, upon the motion of PM USA, the trial court entered an amended final judgment of approximately $12.3 million in compensatory damages and approximately $24.5 million in punitive damages to correct a clerical error. On June 22, 2012, the Fourth District Court of Appeal affirmed the amended final judgment. On July 9, 2012, PM USA filed a motion for rehearing.
 
 
 
 
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. In May 2012, PM USA paid an amount of approximately $262,000 in satisfaction of the judgment and associated costs and interest.
 
 
 
 

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Date
Plaintiff
Verdict
Post-Trial Developments
August 2009
Barbanell
A Broward County jury returned a verdict in favor of the plaintiff, awarding $5.3 million in compensatory damages. The judge had previously dismissed the punitive damages claim. In September 2009, the trial court entered final judgment and awarded the plaintiff $1.95 million in actual damages. The judgment reduced the jury's $5.3 million award of compensatory damages due to the jury allocating 36.5% of the fault to PM USA.
A notice of appeal was filed by PM USA in September 2009, and PM USA posted a $1.95 million appeal bond. In February 2012, the Florida Fourth District Court of Appeals reversed the judgment, holding that the statute of limitations barred the plaintiff's claims. The plaintiff has filed a motion for rehearing en banc or, in the alternative, for certification to the Florida Supreme Court.
 
 
 
 
February 2009
Hess
A Broward County jury found in favor of plaintiffs and against PM USA. The jury awarded $3 million in compensatory damages and $5 million in punitive damages. In June 2009, the trial court entered final judgment and awarded plaintiffs $1.26 million in actual damages and $5 million in punitive damages. The judgment reduced the jury's $3 million award of compensatory damages due to the jury allocating 42% of the fault to PM USA.
PM USA noticed an appeal to the Fourth District Court of Appeal in July 2009. In April 2012, PM USA filed a motion to stay the appeal pending the decision of the Florida Supreme Court on whether to review the Douglas case. On May 2, 2012, the Fourth District denied PM USA's motion to stay the appeal. The Fourth District also reversed and vacated the punitive damages award and affirmed the judgment in all other respects, upholding the compensatory damages award of $1.26 million. On June 7, 2012, both parties filed rehearing motions with the Fourth District.

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), several state appellate rulings have superseded the Eleventh Circuit's ruling on Florida state law. These include Martin, an Engle progeny case against R.J. Reynolds in Escambia County, J. Brown, an Engle progeny case against R.J. Reynolds in Broward County, and Douglas, an Engle progeny case against PM USA, R.J. Reynolds and Liggett Group in Hillsborough County. In Martin, the Florida First District Court of Appeal rejected the B. Brown ruling as a matter of state law and upheld the use of the Engle findings to relax plaintiffs' burden of proof. R.J. Reynolds had sought Florida Supreme Court review in that case but, in July 2011, the Florida Supreme Court declined to hear the appeal. In December 2011, petitions for certiorari were filed with the United States Supreme Court by R.J. Reynolds in Campbell, Martin, Gray and Hall and by PM USA and Liggett Group in Campbell. The Supreme Court denied the defendants' certiorari petitions in March 2012.

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

In Douglas, in March 2012, the Florida Second District Court of Appeal issued a decision affirming the judgment of the trial court in favor of the plaintiff and upholding the use of the Engle jury findings but certified to the Florida Supreme Court the question of whether granting res judicata effect to the Engle jury findings violates defendants' federal due process rights. In April 2012, the defendants in Douglas filed a notice to invoke discretionary jurisdiction with the Florida Supreme Court. On May 15, 2012, the Florida Supreme Court accepted jurisdiction of the case. Argument is scheduled for

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September 6, 2012.

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 additional outstanding judgments in the Engle progeny cases before the final adjudication of these issues by the Florida Supreme Court or the United States Supreme Court.

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

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

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

Scott Class Action
 
Following a 2004 verdict that awarded plaintiffs approximately $590 million to fund a 10-year smoking cessation program and a series of appeals and other post-trial motions, PM USA recorded in the second quarter of 2011 a provision on its condensed consolidated balance sheet of approximately $36 million related to the judgment and approximately $5 million related to interest, which was in addition to a previously recorded provision of approximately $30 million. In August 2011, PM USA paid its share of the judgment and interest in an amount of approximately $70 million. The defendants' payments have been deposited into a court-supervised fund that is intended to pay for smoking cessation programs.

In October 2011, plaintiffs' counsel filed a motion for an award of attorneys' fees and costs. Plaintiffs' counsel sought additional fees from defendants of up to $673 million. Additionally, plaintiffs' counsel requested an award of approximately $13 million in costs. In March 2012, the trial court denied defendants' motion challenging plaintiffs' counsel's request that defendants pay their attorneys' fees directly, as opposed to out of the court-supervised fund. Defendants subsequently filed a petition for a supervisory writ challenging the decision to the Louisiana Fourth Circuit Court of Appeal.

On May 10, 2012, the parties reached a settlement on the amount of fees and costs to be awarded to plaintiffs' counsel. Plaintiffs agreed that any recovery of fees and costs would come from the court-supervised fund, not the defendants, and indicated they would seek approximately $114 million from the fund. In exchange, defendants agreed to waive 50% of their right to a refund of any unspent money in the fund after the 10-year program is completed. The agreement is not contingent on the trial court's granting plaintiffs' request for additional costs and fees. The trustee of the fund intervened to challenge whether the plaintiffs' lawyers should get any money from the fund or, alternatively, the amount they would recover from the fund. Plaintiffs and defendants are challenging the standing of the trustee. Argument is scheduled for August 22, 2012.

Other Medical Monitoring Class Actions


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

In Caronia, in February 2010, the district court granted in part PM USA's summary judgment motion, dismissing plaintiffs' strict liability and negligence claims and certain other claims, granted plaintiffs leave to amend their complaint to allege a medical monitoring cause of action and requested further briefing on PM USA's summary judgment motion as to plaintiffs' implied warranty claim and, if plaintiffs amend their complaint, their medical monitoring claim. In March 2010, plaintiffs filed their amended complaint and PM USA moved to dismiss the implied warranty and medical monitoring claims. In January 2011, the district court granted PM USA's motion, dismissed plaintiffs' claims and declared plaintiffs' motion for class certification moot in light of the dismissal of the case. The plaintiffs have appealed that decision to the United States Court of Appeals for the Second Circuit. Argument before the Second Circuit was heard in March 2012.

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

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

Health Care Cost Recovery Litigation

Overview
 
In the health care cost recovery litigation, governmental entities 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 2011, in the health care cost recovery case brought against PM USA and other defendants by the City of St. Louis, Missouri and approximately 40 Missouri hospitals, a verdict was returned in favor of the defendants.

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

In addition to the cases brought in the United States, health care cost recovery actions have also been brought against tobacco industry participants, including PM USA and Altria Group, Inc., in Israel (dismissed), the Marshall Islands (dismissed), and Canada (8), and other entities have stated that they are considering filing such actions. In the case in Israel (Clalit), in July 2011, the Israel Supreme Court reversed the trial court's decision denying defendants' motion to dismiss and dismissed the case. In August 2011, plaintiff filed a motion for rehearing with the Israel Supreme Court, which the court denied in January 2012. This litigation has concluded.

In September 2005, in the first of the five 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.

Since the beginning of 2008, the Canadian Provinces of New Brunswick, Ontario, Newfoundland and Labrador, Quebec, Alberta, Manitoba and Saskatchewan have all brought health care reimbursement claims against cigarette manufacturers. PM USA is named as a defendant in the British Columbia and Quebec cases, while both Altria Group, Inc. and PM USA are named as defendants in the New Brunswick, Ontario, Newfoundland and Labrador, Quebec, Alberta, Manitoba and Saskatchewan 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 Master Settlement Agreement (the "MSA") with 46 states, the District of Columbia, Puerto Rico, Guam, the United States Virgin

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Islands, American Samoa and the Northern Marianas to settle asserted and unasserted health care cost recovery and other claims. PM USA and certain other United States tobacco product manufacturers had previously settled similar claims brought by Mississippi, Florida, Texas and Minnesota (together with the MSA, the "State Settlement Agreements"). The State Settlement Agreements require that the original participating manufacturers make substantial annual payments of approximately $9.4 billion each year, subject to adjustments for several factors, including inflation, market share and industry volume. In addition, the original participating manufacturers are required to pay settling plaintiffs' attorneys' fees, subject to an annual cap of $500 million. For the three months ended June 30, 2012 and June 30, 2011, the aggregate amount recorded in cost of sales with respect to the State Settlement Agreements and the Fair and Equitable Tobacco Reform Act of 2004 ("FETRA") was approximately $1.3 billion for each period. For the six months ended June 30, 2012 and June 30, 2011, the aggregate amount recorded in cost of sales with respect to the State Settlement Agreements and FETRA was approximately $2.4 billion for each period.

The State Settlement Agreements also include provisions relating to advertising and marketing restrictions, public disclosure of certain industry documents, limitations on challenges to certain tobacco control and underage use laws, restrictions on lobbying activities and other provisions.
Possible Adjustments in MSA Payments for 2003 to 2011
Pursuant to the provisions of the MSA, domestic tobacco product manufacturers, including PM USA, who are original signatories to the MSA (the "Original Participating Manufacturers" or "OPMs") are participating in proceedings that may result in downward adjustments to the amounts paid by the OPMs and the other MSA-participating manufacturers to the states and territories that are parties to the MSA for each of the years 2003 to 2011. The proceedings relate to an MSA payment adjustment (the "NPM Adjustment") based on the collective loss of market share for the relevant year by all participating manufacturers who are subject to the payment obligations and marketing restrictions of the MSA to non-participating manufacturers ("NPMs") who are not subject to such obligations and restrictions.
As part of these proceedings, an independent economic consulting firm jointly selected by the MSA parties or otherwise selected pursuant to the MSA's provisions is required to determine whether the disadvantages of the MSA were a "significant factor" contributing to the participating manufacturers' collective loss of market share for the year in question. If the firm determines that the disadvantages of the MSA were such a "significant factor," each state may avoid a downward adjustment to its share of the participating manufacturers' annual payments for that year by establishing that it diligently enforced a qualifying escrow statute during the entirety of that year. Any potential downward adjustment would then be reallocated to any states that do not establish such diligent enforcement. PM USA believes that the MSA's arbitration clause requires a state to submit its claim to have diligently enforced a qualifying escrow statute to binding arbitration before a panel of three former federal judges in the manner provided for in the MSA. A number of states have taken the position that this claim should be decided in state court on a state-by-state basis.
 
An independent economic consulting firm, jointly selected by the MSA parties, determined that the disadvantages of the MSA were a significant factor contributing to the participating manufacturers' collective loss of market share for each of the years 2003 − 2005. A different independent economic consulting firm, jointly selected by the MSA parties, determined that the disadvantages of the MSA were a significant factor contributing to the participating manufacturers' collective loss of market share for the year 2006. Following the firm's determination for 2006, the OPMs and the states agreed that the states would not contest that the disadvantages of the MSA were a significant factor contributing to the participating manufacturers' collective loss of market share for the years 2007, 2008 and 2009. Accordingly, the OPMs and the states have agreed that no "significant factor" determination by an independent economic consulting firm will be necessary with respect to the participating manufacturers' collective loss of market share for the years 2007, 2008 and 2009 (the "significant factor agreement"). This agreement became effective for 2007, 2008 and 2009 on February 1, 2010, 2011 and 2012, respectively. The OPMs and the states have agreed to extend the significant factor agreement to apply to the participating manufacturers' collective loss of market share for 2010 and 2011, as well as to any collective loss of market share that the participating manufacturers experience for 2012. This agreement will become effective for 2010 on February 1, 2013 and for 2011 on February 1, 2014. If the MSA's Independent Auditor determines that the participating manufacturers collectively lost market share for 2012, this agreement will become effective for 2012 on February 1, 2015.
 
Following the "significant factor" determination with respect to 2003, thirty-eight states filed declaratory judgment actions in state courts seeking a declaration that the state diligently enforced its escrow statute during 2003. The OPMs and other MSA-participating manufacturers responded to these actions by filing motions to compel arbitration in accordance with the

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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. On June 25, 2012, the participating manufacturers and Montana entered into a consent decree pursuant to which Montana will not be subject to the 2003 NPM Adjustment.

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. Following the completion of discovery, the participating manufacturers determined to continue to contest the 2003 diligent enforcement claims of 33 states, the District of Columbia and Puerto Rico and to no longer contest such claims by twelve states and four U.S. territories (the "non-contested states"). As a result, the non-contested states will not be subject to the 2003 NPM Adjustment, and their share of any such NPM Adjustment, along with the shares of any states found by the arbitration panel to have diligently enforced during 2003, will be reallocated in accordance with the MSA to those states, if any, found by the panel not to have diligently enforced during 2003. Proceedings to determine state diligent enforcement claims for the years 2004 through 2011 have not yet been scheduled.
 
Once a significant factor determination in favor of the participating manufacturers for a particular year has been made by an economic consulting firm, or the states' agreement not to contest significant factor for a particular year has become effective, PM USA has the right under the MSA to pay the disputed amount of the NPM Adjustment for that year into a disputed payments account or withhold it altogether. PM USA has made its full MSA payment due in each year from 2006 - 2010 to the states (subject to a right to recoup the NPM Adjustment amount in the form of a credit against future MSA payments), even though it had the right to deduct the disputed amounts of the 2003 - 2007 NPM Adjustments, as described above, from such MSA payments. PM USA paid its share of the amount of the disputed 2008 and 2009 NPM Adjustments shown below into the MSA's disputed payments account in connection with its MSA payments due in 2011 and 2012, respectively. The approximate maximum principal amounts of PM USA's share of the disputed NPM Adjustment for the years 2003 through 2011, as currently calculated by the MSA's Independent Auditor, are as follows (the amounts shown below do not include the interest or earnings thereon to which PM USA believes it would be entitled in the manner provided in the MSA and do not reflect the partial liability reduction for the 2003 NPM Adjustment pursuant to the arbitration agreement described above):
Year for which NPM Adjustment calculated
 2003 
 2004
 2005 
 2006 
 2007 
 2008 
 2009 
2010
2011
 
 
 
 
 
 
 
 
 
 
Year in which deduction for NPM Adjustment may be taken
2006
2007
2008
2009
2010
2011
2012
2013
2014
 
 
 
 
 
 
 
 
 
 
PM USA's Approximate Share of Disputed NPM Adjustment (in millions)
$337
$388
$181
$154
$185
$252
$206
$208
$137


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The foregoing amounts may be recalculated by the MSA's Independent Auditor if it receives information that is different from or in addition to the information on which it based these calculations, including, among other things, if it receives revised sales volumes from any participating manufacturer. Disputes among the manufacturers could also reduce the foregoing amounts. The availability and the precise amount of any NPM Adjustment for 2003 - 2011 will not be finally determined until 2013 or thereafter. There is no certainty that the OPMs and other MSA-participating manufacturers will ultimately receive any adjustment as a result of these proceedings, and the amount of any adjustment received for a year could be less than the amount for that year listed above. If the OPMs do receive such an adjustment through these proceedings, the adjustment would be allocated among the OPMs pursuant to the MSA's provisions. It is expected that PM USA would receive its share of any adjustments for 2003 - 2007 in the form of a credit against future MSA payments and its share of any adjustment for 2008 or 2009 in the form of a withdrawal from the disputed payments account.

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

Other Disputes Related to MSA Payments

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

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

PM USA anticipates that this arbitration will not be concluded until 2013. No assurance can be given that PM USA will preva