RJ REYNOLDS TOBACCO HOLDINGS INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


(Mark One)
[X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
		OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended September 30, 2002
		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: 1-6388

R.J. Reynolds Tobacco Holdings, Inc.

(Exact name of registrant as specified in its charter)


Delaware		56-0950247
(State or other jurisdiction of		(I.R.S. Employer Identification Number)
incorporation or organization)

401 North Main Street

Winston-Salem, NC 27102-2866

(Address of principal executive offices) (Zip Code)

(336) 741-5500

(Registrant’s telephone number, including area code)

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: 88,197,022 shares of common stock, par value $.01 per share, as of October 14, 2002

INDEX


		Page

Part I — Financial Information

Item 1.	Financial Statements
	Condensed Consolidated Statements of Income (Unaudited) — Three and Nine Months Ended September 30, 2002 and 2001		3
	Condensed Consolidated Statements of Cash Flows (Unaudited) — Nine Months Ended September 30, 2002 and 2001		4
	Condensed Consolidated Balance Sheets — September 30, 2002 (Unaudited) and December 31, 2001		5
	Notes to Condensed Consolidated Financial Statements (Unaudited)		6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		34

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		45

Item 4.	Controls and Procedures		45

Part II — Other Information

Item 1.	Legal Proceedings		46

Item 6.	Exhibits and Reports on Form 8-K		48

Signature			49

Certifications			50

PART I — Financial Information

Item 1. Financial Statements

R.J. REYNOLDS TOBACCO HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Millions, Except Per Share Amounts)

(Unaudited)



				For the Three						For the Nine
				Months Ended						Months Ended
				September 30,						September 30,

				2002			2001			2002			2001

Net sales*				$	1,585		$	1,628		$	4,805		$	4,788
Costs and expenses:
		Cost of products sold*			985			916			2,843			2,729
		Selling, general and administrative expenses			348			355			1,041			1,057
		Amortization of trademarks and goodwill			—			91			—			272

			Operating income		252			266			921			730
Interest and debt expense					38			37			110			113
Interest income					(16	)		(32	)		(44	)		(110	)
Other expense, net					2			3			7			11

			Income from continuing operations before income taxes		228			258			848			716
Provision for income taxes					89			130			331			361

			Income from continuing operations		139			128			517			355
Discontinued operations:
		Loss on sale of discontinued businesses, net of income taxes			—			(9	)		—			(9	)

			Income before cumulative effect of accounting change		139			119			517			346
Cumulative effect of accounting change, net of income taxes					—			—			(502	)		—

			Net income	$	139		$	119		$	15		$	346

Basic income (loss) per share:
	Income before cumulative effect of accounting change			$	1.58		$	1.34		$	5.76		$	3.62
	Loss on sale of discontinued businesses				—			(.10	)		—			(.10	)
	Cumulative effect of accounting change				—			—			(5.59	)		—

			Net income	$	1.58		$	1.24		$	0.17		$	3.52

Diluted income (loss) per share:
	Income before cumulative effect of accounting change			$	1.56		$	1.31		$	5.64		$	3.55
	Loss on sale of discontinued businesses				—			(.09	)		—			(.09	)
	Cumulative effect of accounting change				—			—			(5.48	)		—

			Net income	$	1.56		$	1.22		$	0.16		$	3.46

Dividends declared per share				$	0.95		$	0.875		$	2.775		$	2.43

* Excludes excise taxes of $457 million and $394 million for the three months ended September 30, 2002 and 2001, respectively, and $1,337 million and $1,161 million for the nine months ended September 30, 2002 and 2001, respectively.

See Notes to Condensed Consolidated Financial Statements

R.J. REYNOLDS TOBACCO HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Millions)

(Unaudited)



				For the Nine Months
				Ended September 30,

				2002			2001

Cash flows from (used in) operating activities:
	Net income			$	15		$	346
	Adjustments to reconcile to net cash flows from (used in) operating activities:
		Cumulative effect of accounting change, net of income taxes			502			—
		Depreciation and amortization			109			369
		Deferred income tax expense (benefit)			76			(80	)
		Changes in other working capital items, net of acquisition			(23	)		(2	)
		Changes in tobacco settlement and related accruals			471			671
		Other, net			(51	)		(23	)

			Net cash flows from operating activities		1,099			1,281

Cash flows from (used in) investing activities:
		Purchases of short-term investments			(504	)		(205	)
		Acquisition, net of cash acquired			(339	)		—
		Capital expenditures			(66	)		(36	)
		Other, net			17			(12	)

			Net cash flows used in investing activities		(892	)		(253	)

Cash flows from (used in) financing activities:
		Proceeds from issuance of long-term debt			745			—
		Repurchase of common stock			(398	)		(369	)
		Dividends paid on common stock			(250	)		(235	)
		Repayments of long-term debt			—			(73	)
		Proceeds from exercise of stock options			38			43

			Net cash flows from (used in) financing activities		135			(634	)

Net change in cash and cash equivalents					342			394
Cash and cash equivalents at beginning of period					2,020			2,543

Cash and cash equivalents at end of period				$	2,362		$	2,937

Income taxes paid, net of refunds				$	(49	)	$	93
Interest paid				$	81		$	83
Tobacco settlement and related expense payments				$	1,429		$	1,247

See Notes to Condensed Consolidated Financial Statements

R.J. REYNOLDS TOBACCO HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Millions)


			September 30,			December 31,
			2002			2001

			(Unaudited)
Assets
Current assets:
	Cash and cash equivalents		$	2,362		$	2,020
	Short-term investments			711			207
	Accounts and notes receivable, net			114			106
	Inventories			778			730
	Deferred income taxes			434			538
	Prepaid excise taxes and other			256			255

		Total current assets		4,655			3,856
Property, plant and equipment, net				1,046			1,050
Trademarks, net				2,099			2,773
Goodwill, net				7,090			6,875
Other assets and deferred charges				583			496

			$	15,473		$	15,050

Liabilities and stockholders’ equity
Current liabilities:
	Accounts payable		$	72		$	74
	Tobacco settlement and related accruals			1,998			1,520
	Accrued liabilities			1,089			1,155
	Current maturities of long-term debt			783			43

		Total current liabilities		3,942			2,792
Long-term debt (less current maturities)				1,754			1,631
Deferred income taxes				1,399			1,726
Long-term retirement benefits				571			514
Other noncurrent liabilities				367			361
Commitments and contingencies
Stockholders’ equity:
	Common stock (shares issued: 115,377,877 in 2002 and 114,046,712 in 2001)			1			1
	Paid-in capital			7,396			7,371
	Retained earnings			1,358			1,593
	Accumulated other comprehensive loss			(120	)		(121	)
	Unamortized restricted stock			(22	)		(42	)

				8,613			8,802
	Treasury stock, at cost (shares: 26,540,855 in 2002 and 19,810,832 in 2001)			(1,173	)		(776	)

		Total stockholders’ equity		7,440			8,026

			$	15,473		$	15,050

See Notes to Condensed Consolidated Financial Statements

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1 — Interim Reporting

Basis of Presentation

The condensed consolidated financial statements include the accounts of R.J. Reynolds Tobacco Holdings, Inc., referred to as RJR, and its wholly owned subsidiaries. RJR’s wholly owned subsidiaries include its operating subsidiaries, R. J. Reynolds Tobacco Company, referred to as RJR Tobacco, and Santa Fe Natural Tobacco Company, Inc., referred to as Santa Fe. RJR also wholly owns RJR Acquisition Corp.

The equity method is used to account for investments in businesses that RJR does not control, but has the ability to significantly influence operating and financial policies. The cost method is used to account for investments in which RJR does not have the ability to significantly influence operating and financial policies. All material intercompany balances have been eliminated.

The accompanying unaudited, interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and, in management’s opinion, contain all adjustments, consisting only of normal recurring items, necessary for a fair statement of the results for the periods presented. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. For interim reporting purposes, certain costs and expenses are charged to operations in proportion to the estimated total annual amount expected to be incurred. The results for the interim period ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.

The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related footnotes, which appear in RJR’s Annual Report on Form 10-K for the year ended December 31, 2001. For comparability, certain reclassifications were made to conform prior periods to the current presentation format. All dollar amounts are presented in millions unless otherwise noted.

On January 16, 2002, RJR acquired, with cash, 100% of the voting stock of privately held Santa Fe. Fiesta Acquisition Corp., a wholly owned subsidiary of RJR, merged with and into Santa Fe, and Santa Fe, being the surviving corporation, became a wholly owned subsidiary of RJR. The acquisition was accounted for as a purchase, with its cost of $354 million allocated on the basis of the estimated fair market value of the assets acquired and liabilities assumed. The results of operations of Santa Fe have been included in the accompanying condensed consolidated statements of income since January 16, 2002. Although the operations of Santa Fe meet the criteria to be an operating segment, the financial condition and results of operations of Santa Fe do not meet the criteria to be reportable. As a result, information related to Santa Fe is not generally disclosed separately in this document.

Recently Adopted Accounting Pronouncements

On January 1, 2002, RJR adopted the Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” As of December 31, 2001, the carrying values of RJR Tobacco’s goodwill and trademarks were $6.9 billion and $2.8 billion, respectively. RJR Tobacco recorded goodwill and trademark amortization expense of $91 million and $272 million during the three and nine months ended September 30, 2001, respectively. As of January 1, 2002, RJR Tobacco’s trademarks and goodwill are no longer amortized.

Notes to Condensed Consolidated Financial Statements (Unaudited) (Continued)

The following table reconciles net income to its amount adjusted to exclude goodwill and trademark amortization expense:


		Three Months Ended		Nine Months Ended
		September 30, 2001		September 30, 2001

Reported net income		$	119	$	346
Add back: goodwill amortization			65		195
trademark amortization, net of tax			16		47

Adjusted net income		$	200	$	588

Basic income per share:
	Reported net income	$	1.24	$	3.52
	Adjusted net income		2.09		5.99
Diluted income per share:
	Reported net income	$	1.22	$	3.46
	Adjusted net income		2.05		5.87

The criteria provided in SFAS No. 142 require the testing of impairment based on fair value. For initial application of SFAS No. 142, an independent appraisal firm was engaged to value RJR’s goodwill and trademarks as of January 1, 2002. RJR’s goodwill as of January 1, 2002 was attributable to one reporting unit, RJR Tobacco, which comprises substantially all of RJR’s consolidated results of operations and financial condition.

No goodwill impairment was indicated, since the fair value of RJR was determined to be greater than its carrying value using several valuation techniques, including discounted cash flow analysis. RJR’s most recent fair value determination resulted in an amount that substantially exceeded the carrying value. Accordingly, RJR is not required to annually determine the fair value of the reporting unit, as long as its assets and liabilities do not change significantly, and it is considered unlikely that the current fair value would be less than the carrying value.

The changes in the carrying amount of goodwill during the nine months ended September 30, 2002 were:


*	Excludes excise taxes of $457 million and $394 million for the three months ended September 30, 2002 and 2001, respectively, and $1,337 million and $1,161 million for the nine months ended September 30, 2002 and 2001, respectively.