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Reynolds American (NYSE:RAI)

Q4 2012 Earnings Call

February 12, 2013 9:00 am ET

Executives

Morris Moore

Daniel M. Delen - Chief Executive Officer, President and Director

Thomas R. Adams - Chief Financial Officer and Executive Vice President

Analysts

David J. Adelman - Morgan Stanley, Research Division

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Christopher R. Growe - Stifel, Nicolaus & Co., Inc., Research Division

Thilo Wrede - Jefferies & Company, Inc., Research Division

Vivien Azer - Citigroup Inc, Research Division

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Michael Lavery - CLSA Asia-Pacific Markets, Research Division

Karen Lamark

Operator

Good day, ladies and gentlemen, and welcome to the Reynolds American Fourth Quarter Earnings Conference Call. [Operator Instructions] I'd now like to turn the conference over to your host, Mr. Morris Moore, Vice President of Investor Relations. Please go ahead.

Morris Moore

Good morning, and thank you for joining our call. Today, we'll discuss Reynolds American's results for the fourth quarter and full year, as well as our outlook for 2013. As usual, our discussion will focus on adjusted results, as management believes this better reflects our underlying business performance. A reconciliation of reported to adjusted earnings is in our press release, which is available on our website at reynoldsamerican.com. Joining me this morning are RAI's President and CEO, Dan Delen; and Tom Adams, our CFO.

The information we're about to discuss includes forward-looking statements. When we talk about future results or events, a number of factors could generate results that are materially different from our projections today. These factors include, but are not limited to, items detailed in our press release and SEC filings. Except as provided by Federal Securities laws, we're not required to publicly update or revise any forward-looking statements.

And now I'll turn the call over to Dan.

Daniel M. Delen

Good morning, everyone. I'm very pleased to report that the strong finish by our operating companies in 2012 contributed to solid growth in RAI's fourth quarter and full year adjusted earnings and margin. And our company's momentum positions us well for additional progress this year. As you're aware, the environment in 2012 was quite difficult. Continued economic weakness, combined with an intensely competitive marketplace presented significant challenges for our businesses. Even so, our company's successful business strategy continued to provide a strong and flexible foundation for profitable growth and for returning value to our shareholders.

RAI's operating companies pay close attention to productivity and effectively use the additional resources that were generated by the business review conducted early last year. They also found new opportunities for marketplace gains, while continuing to build the equity of their powerful key brands. In addition, our companies are leading the way in innovation with the development of exciting new products that will help achieve sustainable, long-term growth in emerging categories. Two of these new products, Niconovum USA's Zonnic nicotine replacement therapy gum and the Vuse e-cigarette, being developed by R.J. Reynolds Vapor Company, offer excellent potential for long-term commercial success. But it's also important to note that these innovations demonstrate our commitment to leading the transformation of the tobacco industry and reducing the harm caused by tobacco.

Niconovum is taking a fresh approach to smoking cessation, offering positive and inspirational messaging for the Zonnic brand. They're also making the product more accessible to adult tobacco consumers both in terms of price and availability. It's still early days since Zonnic entered its first U.S. market in Des Moines, Iowa, but Niconovum is already getting positive consumer feedback that will serve to shape Zonnic's expansion plans.

Now turning to the vapor market. I'm happy to say that the development of our first e-cigarette under the Vuse brand name is going very well. Vuse is a highly differentiated product, offering proprietary technology that delivers superior vapor and taste. By addressing the changing preferences of adult tobacco consumers, both Zonnic and Vuse offer exciting potential for long-term growth. We'll be giving you more details about these and other innovation as we move through the year.

I'll note here that RAI's operating companies expect to make significant investments in expanding these product innovations this year, as well as investments in equity building initiative on each of their key brands. These investments are reflected in RAI's guidance for 2013, along with the impact of the recent agreement in principal with 19 jurisdictions to settle the NPM Adjustment dispute under the MSA. As I'm sure you're aware, the proposed settlement is pending review by the arbitration panel. So we expect to be slightly above our historical trend of mid- to high-single-digit EPS growth, with an increase of 6% to 11% for the year.

Now I'll discuss the fourth quarter performance in more detail. R.J. Reynolds proved resilient in a challenging year, marked by unprecedented levels of competitive promotional spending. However, competitive promotional grades per pack moderated as the year progressed. R.J. Reynolds' fourth quarter adjusted operating income declined as a result of lower cigarette volumes and higher promotional spending. The company's discounting was higher in the quarter, primarily due to defenseless support of Camel's capsule styles.

R.J. Reynolds' shipment volume declined 2.7% in the fourth quarter, driven by losses in the company's non-focused value brands, which received little or no promotional support. For the industry as a whole, fourth quarter shipment volume was down 0.8%. Industry wholesale inventories were approximately 8.6 billion units at the end of the fourth quarter, down about 200 million from the prior year quarter, while R.J. Reynolds' wholesale inventories of approximately 2.2 billion were up about 100 million. R.J. Reynolds' total market share declined 9/10 of 1 percentage point in the quarter to 26.4%, with more than half of that decline coming from the company, Doral value brand. I would note that R.J. Reynolds has seen improvement in their total market share trend, which has remained relatively stable over the past 3 quarters.

R.J. Reynolds' gross brands, Camel and Pall Mall, made steady progress as they moved through the year, finishing with a combined fourth quarter market share of 17.5%. This was an increase of 3/10 of 1 percentage point from the prior year quarter and is a testament to the strength of the company to find brand portfolio strategy and ability to find new growth opportunities in a challenging marketplace. Even though it's been a tough year for premium-priced cigarette, Camel continues to deliver solid performance. The brand's fourth quarter market share of 8.6% was in line with the prior year quarter. Continued strong interest by smokers in Camel's distinctive menthol style provided strength for the brand. Camel's menthol style gained 4/10 of 1 percentage point to 3.2%, and these styles now account for almost 40% of Camel's total share.

Camel SNUS, R.J. Reynolds' first smoke-free innovation, is also forging ahead. Camel SNUS is the commanding leader in the growing U.S. SNUS category with market share of about 80%, and Camel SNUS is seeing good growth from its mint style that was expanded nationally last year. R.J. Reynolds is currently rolling out innovative new packaging for Camel SNUS that offers a host of benefits and new opportunities to broaden awareness and trial among adult tobacco consumers. Camel SNUS Fresh Seal packaging delivers the freshness and flavor that consumers have come to expect without refrigeration. This packaging upgrade also offers a sleek-looking thinner tin, which makes it easier to carry or fit into a pocket.

Turning to R.J. Reynolds' other growth brand. Pall Mall wrapped up a challenging year, showing renewed momentum in the fourth quarter. Despite the competitive headwind, Pall Mall achieved a record market share of 8.9%, which was up 3/10 of 1 percentage point from the prior year quarter. It's clear that targeted efforts by R.J. Reynolds to gain awareness and trial on this true value proposition are paying off, and the brand is also benefiting from the recent expansion of its menthol portfolio. These additional menthol styles, Pall Mall Black and White, are performing well, and I expect to see continued progress by Pall Mall this year.

Turning to the moist snuff business. American Snuff had another great year, delivering strong and steady gains in earnings, volume and share. The company's flagship Grizzly brands drove its performance, and the company continued to execute remarkably well. For both the fourth quarter and the full year, American Snuff reported strong growth in adjusted operating income, and there were also substantial increases in adjusted operating margin, which benefited from both higher volume and pricing. The company's fourth quarter shipment volume increased more than 7% from the prior-year quarter, while their moist-snuff market share rose 1 percentage point to 32.6%. Grizzly maintained its position as the nation's best-selling moist snuff brand by increasing fourth quarter shipment volume 8.1% from the prior year quarter, and the brand's market share rose by 1.2 percentage points to 29.2%. Grizzly's reputation for outstanding quality and value continues to open up new opportunities for growth.

Now turning to Santa Fe, which continues to pose impressive gains on every front. Strong volume and pricing growth on the company's Natural American Spirit super premium brand drove operating income and margin substantially higher in the fourth quarter and for the year. Fourth quarter volume of Natural American Spirit was up more than 20%, and the brand's share of market achieved another record high at 1.3%. Let me remind you that this super premium brand remains undiscounted. Santa Fe lets its unique heritage and additive-free and organic style speak for themselves. So that's a quick look at operating performance.

Reynolds American and its operating companies are tackling a challenging and ever-changing environment with strategies that focus on efficiency, brand equity building and innovation. And very successful performance puts us in a strong position for continued profitable growth in the coming year. Now I'll turn the call over to Tom.

Thomas R. Adams

Thank you, Dan, and good morning, everyone.

RAI's operating companies wrapped up the year with positive momentum, enabling Reynolds American to report higher adjusted earnings and margin in the fourth quarter. Our operating companies turned in a resilient performance and were well positioned for growth in the year ahead. So I'm pleased to announce our guidance for 2013 with EPS in the range of $3.15 to $3.30, an increase of 6% to 11% over 2012 adjusted results. This guidance excludes $0.23 per share for a credit against the April 2013 MSA payment related to the partial resolution of the NPM dispute as described in our earnings release. Our guidance takes into account additional investments in the equity building initiatives on our operating companies' 4 key brands, as well as significant investments to support the expansion of the Vuse e-cigarette. It also reflects the favorable impact of the NPM Adjustment dispute resolution for the 2013 volume year, which as Dan has already pointed out, is pending review by the NPM arbitration panel.

Now I'll turn to 2012 results. Reynolds American's fourth quarter adjusted EPS benefited from higher pricing, the impact of our share repurchase program and productivity gains. As a result, EPS increased 5.6% from the prior-year quarter to $0.76. These adjusted results exclude the following charges: $0.31 per share for noncash pension and post-retirement mark-to-market adjustments, which were driven by the decrease in the discount rate to just over 4%; $0.15 for noncash trademark and other intangible impairments, primarily on Winston and Kool brands; $0.02 for early extinguishment of debt; and $0.03 for Engle progeny cases. Those charges reduced recorded fourth quarter EPS by 51.9% from the prior-year quarter to $0.25.

For the full year, adjusted EPS was $2.97, up 5.7% from the prior year. These adjusted results also exclude the items I've just mentioned, as well as charges earlier in the year for other tobacco-related litigation and restructuring. On a reported basis, full year EPS was $2.24, down 6.7% from the prior-year period. RAI delivered good growth in adjusted operating margin for both periods. Fourth quarter was up 0.5 percentage point to 34.6%, and that brought the full year's margin to 34.5%, which was up 1.5 percentage points.

Turning to our operating companies performance, where I'll focus on adjusted results to provide better perspective on their underlying business. At R.J. Reynolds, fourth quarter adjusted operating income was $571 million, down 4.5% from the prior year quarter on declines in cigarette volume and higher promotional spending. For the full year, the company's adjusted operating income was $2.3 billion, down 2.2% from the prior year. The company's fourth quarter adjusted operating margin declined 6/10 of 1 percentage point to 33.1%, while full year margin increased 9/10 of 1 percentage point to 33%.

Turning to our moist snuff business. American Snuff increased fourth quarter adjusted operating income by nearly 15% from the prior-year quarter to $100 million, reflecting gains in moist snuff volumes and pricing. For the full year, the company posted an increase of 10% in adjusted operating income to $379 million. The company's adjusted operating margin showed excellent growth for both the quarter and the year. Fourth quarter adjusted operating margin increased 3.4 percentage points to 56.4%, while full year margin was up 2.5 percentage points at 55.7%.

Now turning to Santa Fe. The company again delivered outstanding performance with operating income up more than 37% to $65 million in the fourth quarter, driven by strong volume and pricing growth on Santa Fe's Natural American Spirit brand. That brought the company's full year operating income to $237 million, up more than 26% from the prior year. Santa Fe's fourth quarter operating margin came in at 49.4%, up 4.8 percentage points from the prior year quarter.

Finally, let me share some of Reynolds American's other financial highlights. RAI made significant progress in the number of areas in the fourth quarter and the year, and I'll start with an update on our debt position. We completed a $2.5 billion public offering of senior debt securities in October at very favorable interest rates. This allowed us to prepay $625 million of debt in December that was scheduled to mature in June of this year.

With respect to our share repurchase program that runs through mid-2014, RAI repurchased 6 million shares for $250 million in the fourth quarter. That brought total share repurchases under the plan to date to 31.7 million shares for $1.3 billion.

During the quarter, RAI also contributed $50 million to its pension plan, which remained well-funded. The funded status of these plans declined slightly to about 86% on a PBO basis due to the decline in the discount rate that I've already mentioned, and the company closed the year with cash of $2.5 billion.

So in conclusion, RAI continued to find good opportunities to return value to shareholders in 2012, including the 5.4% increase in our dividend last May to an annualized rate of $2.36 per share. Our operating companies continue to focus on productivity across the board, including the successful business to review earlier last year. Our companies are also making effective use of resources in the development of their new products that will sustain profitable growth over the long term.

Thank you. We'll now turn to the Q&A portion of the call. Ali, would you remind our callers how to get into the queue?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from David Adelman of Morgan Stanley.

David J. Adelman - Morgan Stanley, Research Division

I want to understand the guidance and what you're really saying about the underlying growth that you envision for next year, for 2013. Just to be clear, the guidance of $3.15 to $3.30, am I correct that, that includes the benefit of about $200 million in lower MSA cost than you otherwise would have incurred that you'll pay in 2014 because of the proposed resolution? Is that correct? That's about $0.23 a share in benefit.

Daniel M. Delen

That is correct, David. I think the way we've looked in terms of establishing guidance is that, that's actually included, and maybe it's worth just sort of recognizing, and me sharing with the rest of the listeners as well, is that this is actually part compensation for some of the impact of the MSA and disproportionate impact that the MSA had on our company historically. So we're taking the opportunity to reinvest a portion of those benefits back in our innovation capability and some of the new products that we've talked about, and also in the equity spend behind some of our key assets. Those are key growth brands, and so we'll be looking and rewarding shareholders with part of that benefit, and also reinvesting part of that benefit as we go forward.

David J. Adelman - Morgan Stanley, Research Division

But am I right that on a net basic -- assuming that, that will all had flown to the bottom line, I mean, you can basically get to the underlying rate of earnings growth year-on-year simply with flat operating income in your share buyback.

Daniel M. Delen

Well, that's certainly one way to look at it, David. I think the way we would look at it is we would say that this opportunity has actually presented itself to us, so we're taking part of that benefit and reinvesting it behind our innovations and behind some of the equity spent behind our key growth assets.

David J. Adelman - Morgan Stanley, Research Division

Okay. And then just as a follow-up to that point, can you give us a sense of what fraction of that spending may be behind the cigarette business as opposed to some of the other innovations?

Daniel M. Delen

David, as you know, I think for competitive reasons, it's quite difficult for us to go there, to actually detail what some of those investments are. But certainly, based on previous remarks and our Investor Day sort of materials, I think it's clear where we're focused as a company in terms of our innovation effort. We're obviously quite excited about some of the recent developments that we've undertaken in the e-cigarette category. But we're also particularly excited about the performance of some of our key brand assets out in the marketplace, that certainly being NAS in super premium, in cigarettes, Camel and Pall Mall, as well as Grizzly in moist snuff. And I think we've obviously had a look at each one of those key assets that we have going forward and have made the appropriate investment decisions. And I think as we go through the different quarters this year, we can give you a bit more detail as to what some of those investments are as they materialize.

David J. Adelman - Morgan Stanley, Research Division

Okay. And then one last question, just on RJRT's performance in the fourth quarter, on my numbers, pricing was up or price mix about 1% volume, your shipment volume is down 2.7% and yet, profit's down 4.5%. I mean, just knowing those first 2 items, I would have thought profits would have been closer to flat. Were there some unusual costs during the quarter that were not promotional driven that -- during the period?

Thomas R. Adams

David, this is Tom. No, there wasn't anything unusual. I mean, you have the normal kind of year-end clean-up stuff, but I mean there wasn't anything that actually would stand out that's worthy of note.

Operator

Our next question comes from Bonnie Herzog of Wells Fargo.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

So my first question is on pricing. Net pricing decelerated a bit year-over-year and then I think sequentially, so could you talk about that in light of the competitive environment? And as you noted, the competitive promotional levels moderated as the quarter went on, so were you able to take better net pricing towards the end of the fourth quarter? And then how has that progressed this quarter?

Daniel M. Delen

I think really from a -- when we talked sort of the improving competitive environment, I would say that some of the competitive rates actually moderated through the year. I don't think there were substantial differences in the fourth quarter, but really through the year. And so we posted a net price realization in the fourth quarter year-over-year of 1.1%, and that's all excluding the contract manufacturing that we do for BAT in Japan. And if we take the full year number, it's actually up 2.5% year-over-year. But what I think is important when we talk about moderating rates in the marketplace, those are kind of the headline rates, and we need to also then look at how much volume that's actually spread across. So I think it's fair to say that there is a less cents per pack spread across more packs from a competitive point of view. And so I do think it's a fair characterization to say that spend rates have moderated through the year, but I would still call the absolute level of dollars out in the marketplace as being quite intense.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Okay, that's helpful. And then my next question is on Pall Mall. You mentioned that Pall Mall continues to generate strong rates of trial and conversion. So I guess I'm wondering how has this brand evolved over the years in terms of its positioning? And where is it now generating trial? What type of consumers are now trying Pall Mall and where are they coming from? And then further, on your recent success of Pall Mall Black, where is this line extension taking share from? And has this line been incremental?

Daniel M. Delen

Yes. I think -- thanks very much for the question. I think we're quite proud of what Pall Mall has actually achieved, particularly in today's pricing environment. If we take a look at the sequential change for the brand, it's actually -- in the fourth quarter, it came in at 8.9%, which is up 2/10 of 1 percentage point, and year-over-year is up 3/10. And I think given that pricing environment that we've already talked about, I think those are some stellar results. And Bonnie, just to answer your question more specifically, I take you back to a lot of our discussions during Investor Day about Pall Mall and the role it plays in the portfolio and how that proposition actually works with consumers, and we've continued to see good rates of conversion after consumers have actually tried the brand. And I think it's fair to say that in the -- certainly, in the beginning part of 2012, the amount of trial that was available to the brand out in the marketplace was substantially reduced because of the big pricing spend, largely by our competitors. And as that moderated a little bit, we're starting to see consumers reinitiate trial on the brand, and we also at that stage, talked about some of the trial generation activities that we've implemented on Pall Mall, which appear to be paying dividends. And then the second part to your question was about the new menthol line extensions that we have, which is Pall Mall Black and White. We've actually expanded those in the marketplace. They're performing extremely well, slightly ahead of our expectations even, and really there -- I would say that Pall Mall still has additional opportunity in that area. We're still a little bit less than our fair share in that menthol space, but we've closed the gap quite a bit through these new extensions, and so -- and maybe one other thing, just to bear in mind with that, is those extensions are actually priced at the same price as the rest of the Pall Mall family. So we're not talking introductory specials here or anything of the kind, and they're doing very well and, I believe, still have additional growth opportunity out there. And you asked about the source of business of those menthol styles, and there's nothing really of particular note here. It's really sourcing from the entire menthol space proportionately.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Okay, that's helpful, Dan. And I just have one final question on the federal buyout fee, which is going away in late 2014, and as a result, your cost per pack -- and it should be reduced by around $0.06 per pack, which should have a very favorable impact to your margins and earnings growth. So could you talk a little bit about what your plans might for this cost reduction? And how should we think of this benefit?

Thomas R. Adams

Bonnie, this is Tom. We're looking at that, and you've got the math right, and then it will likely manifests itself in differences in 2015. And so what we'll have to do at that juncture is to take a look at the types of pricing that's taken, I mean, or is our price increases going to be lower than they otherwise would or we'll just have to match up with competition and see how it all evolves. But we are watching it and we're aware of it.

Operator

Our next question comes from Chris Growe, Stifel.

Christopher R. Growe - Stifel, Nicolaus & Co., Inc., Research Division

I just had 2 questions for you. I want to understand in terms of the gap in your EPS growth guidance for the year, the sort of $0.15 gap, just some of the factors that could have pushed that higher or lower. I'm just -- so I guess along those lines, like a state excise tax environment, do you have a conservative assumption for promotional levels, that sort of thing, just so we can get a little color on that?

Daniel M. Delen

Yes. I think if I actually look, first of all, from a taxation environment, which is where you asked, from the cigarette side of things, we are expecting, and this is our sort of working assumptions today, is we're expecting a bit less than $0.10 on the cigarette SET front, and maybe a bit less than $0.05 on the moist snuff SET level. I think the principal way, and I believe I've already answered this a little bit earlier, but the way I look at this guidance situation is we're taking the opportunity to make some fairly sizable investments on some of our new innovations out in the marketplace, and in addition, some of the equity spent. And by equity spend, I think that really is what we're trying to target there is long-term sustainable growth of some of our key assets and some of the key brand equities, and so I think it's quite meaningful, those investments. I think at the same time, we obviously look at the pricing environment. We've had to make some assumptions as to where that's actually going, and we continue to evaluate the levels of competitive spend in the marketplace and what that might mean for us in our performance next year. But when we weighed in all those factors together, we believe we've given a prudent level of guidance to the market.

Christopher R. Growe - Stifel, Nicolaus & Co., Inc., Research Division

Okay. I guess, my other question just in relation to, in particular, RJR Tobacco, where you've been really attacking the costs, you have an explicit cost reduction program, and you have obviously ongoing productivity-type opportunities. Can you speak to how much you expect in terms of a benefit from cost savings this year, at least, from the program, if not, if you have any other color on the other productivity side?

Thomas R. Adams

Chris, this is Tom. Well, we announced, post the business review in March of last year, that we would expect to save about $25 million in 2012, which we did and then some, and that's going to grow to about $70 million by 2015. Now these are savings in both SG&A, and they're also manifesting themselves in the cost of products sold line. So we're very confident that we will get to the $70 million. It should build through the course of this year. And as we've said before, cost savings is kind of in our DNA. So outside of the announced programs that we have, we have other initiatives within the company that are generating cost savings, which actually, I mean, in addition to the net price realization we take, basically increases our margins, and that's really where you can see where it shows up.

Operator

Our next question comes from Thilo Wrede of Jefferies.

Thilo Wrede - Jefferies & Company, Inc., Research Division

Dan, throughout the course of the year, you always described the competitive environment as very intense, and you've just made a comment that promotions have been dialed back on a per pack basis, but are spread across more packs. Would you still describe, therefore, the environment as intense? What's your outlook for the coming year?

Daniel M. Delen

Well, obviously, Thilo, it's hard for me to guess exactly what competitive intentions are within the category. I do look -- when we look at it both ways, obviously, what the rate per pack is and also what the total pressure in terms of total spend in the category is. And I would say from a total dollars spent back in the category, we would still describe the environment as being quite intense, but of course, some of the headline rates per pack have gone down a bit over time. So I think it's a fair characterization to say that the pricing environment or the pricing pressure has moderated somewhat in the category, but there is still an inordinate amount of dollars being spent back in the category, and so I think it's a little bit more of a nuanced position this quarter. But all in all, I would say that we're in a better place as a category than we might have been this time last year.

Thilo Wrede - Jefferies & Company, Inc., Research Division

And when I think about your guidance for fiscal '13, kind of what kind of competitive environment is that guidance based on?

Daniel M. Delen

Yes, I think it's obviously very hard for me to give you some guidance in terms of competitive intent. And I think, frankly, that question is a little bit better placed with our -- some of our competitors, but we've obviously internally had to make our assumptions as to where the environment might be heading.

Thilo Wrede - Jefferies & Company, Inc., Research Division

But you wouldn't share with us what those assumptions are?

Daniel M. Delen

No, of course not. Would be very difficult.

Operator

Our next question comes from Vivien Azer of Citi.

Vivien Azer - Citigroup Inc, Research Division

My first question has to do with your investments in next gen and specifically Vuse, given that you're going to be reinvesting some of that MSA benefit back, I'm curious to hear your thoughts about what you expect in terms of FDA regulation of e-cigs.

Daniel M. Delen

That's a great question, Vivien. First of all, on the e-cigarette space, I think we're still awaiting and deem -- what we would call deeming regulation. And as you know, the FDA in the past has sort of signaled its intent to actually pass the new regulation across some of these unregulated tobacco and nicotine spaces. And that certainly is our assumption going forward. Now having said that, we might already have expected some of those regulations to come out, but they haven't yet. So I think our working assumption is that we will eventually see some deeming regulation in the category to cover the e-cigarette space.

Vivien Azer - Citigroup Inc, Research Division

But do you think it'll come in 2013?

Daniel M. Delen

I think, certainly, by all accounts, that is the intent of the FDA. But given how a lot of the regulatory landscape has evolved over time, certainly, I think making predictions are -- is a hazardous enterprise, but all things considered that they have declared that intent, so that is our working assumption.

Vivien Azer - Citigroup Inc, Research Division

Fair enough. My second question has to do with your profit per stick in the RJRT business. I certainly appreciate that the competitive landscape is tough. There've only been a couple of occasions over the last few years where you've seen a quarterly decline in your profit per stick. Can you talk a little bit about how we should think about profit per stick growth, going forward, in 2013?

Daniel M. Delen

Yes. I think, really, the way we look at our business is we obviously watch very keenly the net price realization. If we take a look in the fourth quarter, we had a net price realization x contract manufacturer of 1.1%, and for the year, about 2.5%. At the same time, we keep a very keen eye on the adjusted operating margin and -- on the adjusted operating margin. And from that point of view, I think we've also showed good year-on-year progress. As a total company, total enterprise, we're up 1.5%, but of course, there's a mix issue within that, at Santa Fe Natural Tobacco Company, up 4 percentage points and at the American Snuff Company, 2.5% and at the RJRT, slightly under 1%. So when we look at that, and I think also in the fourth quarter, the thing that had a bearing on our results was what we call our capsule defense plan. As you know, we developed the capsule innovation. We launched it into the marketplace, and that attracted competitive attention. And they also launched into that product category really starting at the back end of the third quarter. But during the fourth quarter, we did deploy some resources to defend our leadership position in that new and innovative category.

Operator

Our next question comes from Judy Hong of Goldman Sachs.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Dan, just going back to your decision to reinvest back some of the NPM settlement benefit into your business, I'm just curious as to sort of your assessment that the decision to reinvest back some of the upside raises potentially the promotional intensity or the competitive intensity that you see in the marketplace. And then in relation to the spending, is there any target that you'd like to achieve, whether it's certain market share targets in cigarettes or certain volume targets in e-cigs and other categories?

Daniel M. Delen

Yes. I think, Judy, the first thing I'd just ask you, maybe just to focus on in terms of some of those investments that we're planning to make, the first one is obviously on the e-cigarette space. And when we actually look at extending the distribution and rolling out that new product that we've developed, and I think those are really equity and innovation-based spending in the e-cigarette space. And I believe we're also trying to be quite clear that we're trying -- that we're planning to make equity investments, so really looking at building the brand equity of some of our key assets, particularly at the Santa Fe National Tobacco Company on their key brand, National American Spirit and Grizzly, as well as Camel and Pall Mall. And so that really is a lot of our efforts that is in support of a lot of the efforts that we've spent a lot of time building the capabilities to do that in terms of our direct-to-consumer work, our consumer engagement work at retail and in other establishments, and so I would really characterize that spend as being equity-based spend.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Okay. I guess following up on the e-cig category, just setting aside the regulatory issues, just your thoughts in terms of how big the category could get. Obviously, the category has grown pretty nicely. Your decision to spend money in that category perhaps speaks to your -- a view on the category having a pretty nice growth potential. So can you give us your views in terms of how you see the category developing? And is there any sign of the category, at this point, eroding or encroaching on the traditional cigarette volume, or is it just still too small to matter?

Daniel M. Delen

Well, Judy, we had quite an extensive discussion about this during our Investor Day. I think we're quite bullish about the category in terms of -- obviously, its growth rate, but what also what can be achieved in the future. We're obviously trying to develop the category in a differentiated way, as is the tradition for our company to come out with a differentiated product, and we believe a significantly superior product to anything in the category today. We believe we have a product that offers a consumer experience that's closer to the smoking experience than anything out there, and of course, we're developing a product that is assembled in the U.S. from food-grade materials, and so we're quite bullish. I think in terms of the impact on the traditional smoking category, it really is -- the category is probably a bit too small to have a definitive view on that. But I think I'd be remiss to say that if that category continues to grow in line with expectations in the future, of course, it will, at that stage, have a substitution effect with regular cigarettes, but I think we're really excited about its potential. And the other thing, maybe a reflection I would have on it is there's a number of different ways to enter a new category. We, of course, as a company could have gone out and actually acquired something within the e-cigarette space, in which case, that acquisition cost would just be a one-off and would be adjusted out of our results, but we've chosen to go an organic route here, which necessarily means that there are ongoing investments. We believe that is the more prudent and for the long term, actually, the cheaper way to come into the category. But those 2 routes were available to us, and we believe we've done it the right way, but that will require investments as we go forward to actually develop the equity, the brand equity and views and to deploy some of that significant new innovation and production capacity for that matter.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Okay, got it. And then just my final question, Tom, I think you said there's 100 million of inventory at the end of the fourth quarter that was higher than the third quarter, is it your expectation that gets unwound in Q1?

Thomas R. Adams

Yes. I mean, we actually ended a little bit higher than we would have expected post the price increase and so, I mean, that will pay back, but then $100 million that is really -- excuse me, 100 million sticks is -- that it may pay back. We'll just have to wait and watch those inventories.

Daniel M. Delen

Yes. I would describe the inventory position as being really relatively inconsequential. There's some small movements on that front, but nothing major.

Operator

[Operator Instructions] Our next question comes from Michael Lavery of CLSA.

Michael Lavery - CLSA Asia-Pacific Markets, Research Division

Just back on e-cigarettes for a minute, obviously, not going with an acquisition has a slower build, I would imagine. Could you give a sense of what the scale or size of that business is? I know you said it's performing well, but how do we think about that in context?

Daniel M. Delen

Well, Michael, thanks for your question. We don't look at it and we don't believe that it will actually lead to a smaller build. I think what we have is a significantly differentiated and superior product bringing to market, so we're actually -- believe that this is a growth maximizing strategy that we've -- are deploying into the marketplace. Of course, it's very difficult at this stage for me to share specific projections in terms of our efforts within the e-cigarette category, but I think as the quarters progress during the year, we'll be giving you more and more information as to what that performance actually looks like.

Michael Lavery - CLSA Asia-Pacific Markets, Research Division

That sounds fair. And yes, I guess, I just meant you're starting at a 0 base instead of having something established. But you're saying you expect a faster growth trajectory once it gets going?

Daniel M. Delen

Yes, largely based on the superior product attributes, certainly, all our testing, and we have a high degree of confidence in terms of the product that we've actually developed.

Michael Lavery - CLSA Asia-Pacific Markets, Research Division

And what's the margin structure look like? How does it compare to, say, the base cigarettes on like, say, a gross margin basis?

Daniel M. Delen

I think very hard for us to actually indicate at this stage. The beginning cycle for any new product launch, obviously, we're going to be more doing more investing than we're actually recovering from a margin point of view, but over time and our projections is that it will be a significant contributor to long-term profitability.

Michael Lavery - CLSA Asia-Pacific Markets, Research Division

Okay. And I was wondering if you could just come back to the settlement for a minute, obviously, it's pending. What are any of the final approvals that need to happen for that to stay on schedule? And what's the timing for some of those?

Daniel M. Delen

Yes, so maybe I'll just remind all the listeners, the proposed settlement has been agreed to by 19 jurisdictions. Those 19 jurisdictions, the 17 states and 2 other territories, account for about 43% of allocable share. And to us, as a company, that's worth about $1 billion over 5 years, okay? And the arbitration panel, they need to permit this agreement to go through. The first hearing was actually held -- has been held already and the second hearing is going to be held on March 7, and we're quietly optimistic that they will allow this agreement to go forward. And I think something else just to bear in mind in all of this is we do believe that this proposed settlement will actually have a positive impact on future enforcement efforts by the states. So we do believe that there is a sort of a forward positive impact as more of these states comply with our obligations under the MSA.

Michael Lavery - CLSA Asia-Pacific Markets, Research Division

Okay. That's great. And then just another question, for the impairment charges in the quarter, I know you've had a trademark impairment on Doral in the past, is this a further reduction on that same brand or was there something else involved now? Could you give us a little color there?

Thomas R. Adams

Michael, this is Tom. Actually, I don't think that we impaired the Doral brand. It was the Kool and the Winston brands that were impaired.

Michael Lavery - CLSA Asia-Pacific Markets, Research Division

And do you see any others that might be at risk there? Where do you think this...

Thomas R. Adams

No, we take a look at this annually in the fourth quarter, and clearly, we marked everything to where we thought it should be, and we'll have another look next year, which is part of our process.

Operator

Our last question comes from Karen Lamark of Federated Investors.

Karen Lamark

A couple of follow-up questions on your planned investments. In terms of the innovations that you've talked about, does that have any implications for CapEx? And if I missed it, I'm sorry, did you give guidance on 2013 CapEx?

Thomas R. Adams

We did not give guidance on 2013 CapEx, but I can tell you that, yes, we are going to make some capital investments, and that our capital expenditures, which were going to be -- I mean, we're going to be filing our K shortly. I mean, later today, and it will be included in there. Those CapEx -- the CapEx that we've got planned for next year is roughly $140 million, and that's up slightly from the roughly $90 million that we spent this year.

Karen Lamark

Okay. And then separately, but related, can you give us some examples of what you consider, I guess, equity building initiatives? I understand, for competitive reasons, you probably don't want to give us a lot of detail, but what do you mean by that or maybe what falls under that definition?

Daniel M. Delen

Yes, it's everything from our efforts, in direct mail, from our consumer engagement efforts which we deploy through our field force, but also through third party agencies, which is really where we're having face-to-face conversations with consumers. It's through the work that we do at different consumer events. So it's really using the marketing communications mix that's available to us as a company.

Karen Lamark

It does not include pricing, is that true?

Daniel M. Delen

That is true.

Operator

I'm showing no further questions at this time, and I would like to turn the conference back over to Mr. Morris Moore for any closing remarks.

Morris Moore

Thank you, again, for joining us on our call today. If you have any follow-on questions, please contact us at Investor Relations. Thanks.

Operator

Ladies and gentlemen, this does conclude today's conference. You may all disconnect, and have a wonderful day.

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