REYNOLDS AMERICAN 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, 2004
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: 1-32258

Reynolds American Inc.

(Exact name of registrant as specified in its charter)


North Carolina		20-0546644
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

401 North Main Street

Winston-Salem, NC 27102-2990

(Address of principal executive offices) (Zip Code)

(336) 741-2000

(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 þ NO o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: 147,555,338 shares of common stock, par value $.01 per share, as of October 15, 2004

INDEX


		Page

Part I — Financial Information

Item 1.	Financial Statements
	Condensed Consolidated Statements of Income (Unaudited) — Three Months and Nine Months Ended September 30, 2004 and 2003		3
	Condensed Consolidated Statements of Cash Flows (Unaudited) — Nine Months Ended September 30, 2004 and 2003		4
	Condensed Consolidated Balance Sheets — September 30, 2004 (Unaudited) and December 31, 2003		5
	Notes to Condensed Consolidated Financial Statements (Unaudited)		6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		61

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		81

Item 4.	Controls and Procedures		81

Part II — Other Information

Item 1.	Legal Proceedings		82

Item 6.	Exhibits and Reports on Form 8-K		82

Signature			86
EX-10.15
EX-10.17
EX-10.18
EX-10.22
EX-10.24
EX-12.1
EX-31.1
EX-31.2
EX-32.1

PART I — Financial Information


Item 1.	Financial Statements

REYNOLDS AMERICAN INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollars in Millions, Except Per Share Amounts)

(Unaudited)



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

			2004			2003			2004			2003

Net sales¹			$	1,866		$	1,384		$	4,436		$	4,033
Costs and expenses:
	Cost of products sold^{1, 2}			1,139			814			2,647			2,418
	Selling, general and administrative expenses			377			313			970			1,028
	Amortization expense			11			—			11			—
	Restructuring and asset impairment charges			(7	)		310			(25	)		365
	Goodwill and trademark impairment charges			—			3,590			—			3,590

		Operating income (loss)		346			(3,643	)		833			(3,368	)
Interest and debt expense				21			25			62			90
Interest income				(7	)		(6	)		(16	)		(23	)
Other (income) expense, net				(1	)		2			4			(4	)

		Income (loss) from continuing operations before income taxes		333			(3,664	)		783			(3,431	)
Provision for (benefit from) income taxes				43			(213	)		221			(121	)

		Income (loss) from continuing operations		290			(3,451	)		562			(3,310	)
Discontinued operations:
	Gain on sale of discontinued businesses, net of income taxes			—			—			1			—

		Income (loss) before extraordinary item		290			(3,451	)		563			(3,310	)
Extraordinary item — gain on acquisition				49			—			49			—

		Net income (loss)	$	339		$	(3,451	)	$	612		$	(3,310	)

Basic income (loss) per share:
	Income (loss) from continuing operations		$	2.29		$	(41.31	)	$	5.70		$	(39.55	)
	Gain on sale of discontinued businesses			—			—			.01			—
	Extraordinary item — gain on acquisition			.38			—			.50			—

		Net income (loss)	$	2.67		$	(41.31	)	$	6.21		$	(39.55	)

Diluted income (loss) per share:
	Income (loss) from continuing operations		$	2.28		$	(41.31	)	$	5.66		$	(39.55	)
	Gain on sale of discontinued businesses			—			—			.01			—
	Extraordinary item — gain on acquisition			.38			—			.49			—

		Net income (loss)	$	2.66		$	(41.31	)	$	6.16		$	(39.55	)

Dividends declared per share			$	0.95		$	0.95		$	2.85		$	2.85

¹ Excludes excise taxes of $525 million and $405 million for the three months ended September 30, 2004 and 2003, respectively, and $1.3 billion and $1.2 billion for the nine months ended September 30, 2004 and 2003, respectively.

² Includes settlement expense of $652 million and $500 million for the three months ended September 30, 2004 and 2003, respectively, and $1.6 billion and $1.5 billion for the nine months ended September 30, 2004 and 2003, respectively.

See Notes to Condensed Consolidated Financial Statements

REYNOLDS AMERICAN INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Millions)

(Unaudited)



			For the
			Nine Months Ended
			September 30,

			2004			2003

Cash flows from (used in) operating activities:
	Net income (loss)		$	612		$	(3,310	)
	Less gain from discontinued operations			(1	)		—
	Adjustments to reconcile to net cash flows from (used in)
		operating activities net of effects of acquisition:
		Depreciation and amortization		83			118
		Goodwill and trademark impairment charges		—			3,590
		Restructuring and asset impairment charges, net of cash payments		(165	)		319
		Deferred income tax benefit		(125	)		(308	)
		Extraordinary item — gain on acquisition		(49	)		—
		Other working capital items		53			79
		Tobacco settlement and related expenses		71			8
		Retirement benefits		(75	)		107
		Other, net		85			4

		Net cash flows from operating activities		489			607

Cash flows from (used in) investing activities:
	Capital expenditures			(50	)		(35	)
	Acquisition, net of cash acquired			204			(9	)
	Distribution from (investment in) equity investees			5			(20	)
	Purchases of short-term investments			(1	)		(4	)
	Proceeds from sale of short-term investments			—			492
	Purchases of long-term investments			(10	)		—
	Proceeds from the sale of business			—			6
	Other, net			(38	)		1

		Net cash flows from investing activities		110			431

Cash flows from (used in) financing activities:
	Repurchase of common stock			(38	)		(72	)
	Repayment of long-term debt			(56	)		(741	)
	Dividends paid on common stock			(243	)		(243	)
	Proceeds from exercise of stock options			33			2

		Net cash flows used in financing activities		(304	)		(1,054	)

Net change in cash and cash equivalents				295			(16	)
Cash and cash equivalents at beginning of period				1,523			1,584

Cash and cash equivalents at end of period			$	1,818		$	1,568

Income taxes paid, net of refunds			$	33		$	34
Interest paid			$	42		$	77
Tobacco settlement and related expense payments			$	1,521		$	1,445

See Notes to Condensed Consolidated Financial Statements

REYNOLDS AMERICAN INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Millions)


			September 30,			December 31,
			2004			2003

			(Unaudited)
Assets
Current assets:
	Cash and cash equivalents		$	1,818		$	1,523
	Short-term investments			108			107
	Accounts and notes receivable, net of allowance			203			67
	Accounts receivable, related party			55			—
	Inventories			1,222			684
	Deferred income taxes			926			713
	Other current assets			178			153
	Assets held for sale			98			84

		Total current assets		4,608			3,331
Property, plant and equipment, net of accumulated depreciation				1,139			894
Trademarks, net of accumulated amortization				1,759			1,759
Goodwill and unallocated purchase price				6,278			3,292
Other intangibles, net of $11 amortization				128			—
Other assets and deferred charges				432			401

			$	14,344		$	9,677


Liabilities and shareholders’ equity
Current liabilities:
	Accounts payable		$	114		$	36
	Tobacco settlement and related accruals			2,319			1,629
	Other current liabilities			1,511			1,134
	Current maturities of long-term debt			50			56
	Liabilities related to assets held for sale			10			10

		Total current liabilities		4,004			2,865
Long-term debt (less current maturities)				1,607			1,671
Deferred income taxes				464			806
Long-term retirement benefits				1,745			1,034
Other noncurrent liabilities				281			244
Commitments and contingencies
Shareholders’ equity:
	Common stock (shares issued: 2004 — 147,433,793; 2003 — 116,430,211)			—			1
	Paid-in capital			8,705			7,377
	Accumulated deficit			(1,997	)		(2,469	)
	Accumulated other comprehensive loss			(465	)		(462	)
	Unamortized restricted stock			—			(23	)

				6,243			4,424
	Less treasury stock (shares: 2003–31,326,603), at cost			—			(1,367	)

		Total shareholders’ equity		6,243			3,057

			$	14,344		$	9,677

See Notes to Condensed Consolidated Financial Statements

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 1 — Completed Business Combination Transactions

On July 30, 2004, R.J. Reynolds Tobacco Holdings, Inc., referred to as RJR, completed its acquisition and combination of the U.S. assets, liabilities and operations of Brown & Williamson Tobacco Corporation, referred to as B&W, a subsidiary of British American Tobacco p.l.c., referred to as BAT, with R.J. Reynolds Tobacco Company, referred to as RJR Tobacco. The combination transactions were accomplished through a new publicly traded holding company, Reynolds American Inc., referred to as RAI, with approximately 147 million shares outstanding, to hold the combined businesses. The combination transactions combined the businesses of two of the largest industry participants with strong brands, creating efficiencies and cost reductions through synergies.

RAI was incorporated in the state of North Carolina on January 5, 2004, for the purpose of facilitating the transactions to combine RJR Tobacco with the U.S. cigarette and tobacco business of B&W. As of January 20, 2004, RJR and B&W each had paid $6,500 to acquire a 50% ownership in RAI, and each had contributed additional capital of $195,500.

Coincident with completion of the combination transactions, B&W contributed a number of previously held shares to RAI, sufficient to reduce its ownership to 61,952,762 shares, or approximately 42% of RAI’s common stock outstanding at the closing. The consideration assigned to the shares issued to and held by B&W was approximately $2.8 billion, or $45.882 per share, based on the average closing price of RJR common stock during the five-day period beginning two days before and ending two days after the announcement of the combination transactions. The shares of RAI previously owned by RJR were cancelled, eliminating RJR’s 50% ownership of RAI. Previous RJR stockholders were issued common shares of RAI in exchange for their existing RJR shares, on a one-for-one basis, resulting in ownership of approximately 58% of RAI’s common stock outstanding at the closing. No indebtedness for borrowed money of B&W was assumed by RAI. The transaction is expected to be tax-free to RJR stockholders, and is being treated as a purchase of B&W by RJR for financial accounting purposes.

As part of the combination transactions, B&W, along with its U.S. operations, transferred cash of $604 million, an amount equal to its pre-closing accrued liabilities under the Master Settlement Agreement, referred to as the MSA, and related agreements. RJR Tobacco and the U.S. cigarette and tobacco operations of B&W were combined in an indirect subsidiary of RAI, referred to as New RJR Tobacco. New RJR Tobacco, and in certain instances, RAI, have agreed to indemnify B&W and its affiliates for, among other things, all liabilities arising before or after the closing that relate to B&W’s U.S. cigarette and tobacco business. These liabilities include B&W’s historic and future tobacco-related litigation liabilities and all liabiliti

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¹	Excludes excise taxes of $525 million and $405 million for the three months ended September 30, 2004 and 2003, respectively, and $1.3 billion and $1.2 billion for the nine months ended September 30, 2004 and 2003, respectively.

²	Includes settlement expense of $652 million and $500 million for the three months ended September 30, 2004 and 2003, respectively, and $1.6 billion and $1.5 billion for the nine months ended September 30, 2004 and 2003, respectively.