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Executives

Morris Moore - Vice President of Investor Relations

Susan M. Ivey, RAI’s - Chairman, President, and Chief Executive officer

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

Analysts

Judy Hong - Goldman Sachs

Steve [Oweirda] - Credit Suisse

David Adelman - Morgan Stanley

Erik Bloomquist - J.P. Morgan

Ann Gurkin - Davenport & Company Llc

David Winters -Wintergreen Advisors

Reynolds American Inc. (RAI) F4Q08 and Full Year Earnings Call February 11, 2009 9:30 AM ET

Operator

Good morning ladies and gentlemen and welcome to the Fourth Quarter Full Year 2008 Earnings Results Conference Call hosted by Reynolds American Inc. (Operator Instructions) As a reminder this call is being recorded. I would now like to introduce your host for today’s conference call Mr. Morris Moore, Vice President of Investor Relations. You may begin your conference.

Morris Moore

Good morning and thank you for joining us. Today we will discuss Reynolds American’s results for the fourth quarter and full year. We will discuss our results on both a reported and adjusted basis. A reconciliation of reported to adjusted earnings is in our press release which can be found on our website at reynoldsamerican.com. Joining me this morning are RAI’s Chairman and CEO Susan Ivey and our CFO Tom Adams.

Before I turn the call over to Susan I need to over the Safe Harbor provisions. During the call we will discuss forward-looking information. When we talk about future results or events a number of factors could make results materially different from our projections. These factors are in our press release and our SEC filings. Except as provided Federal Securities laws, we are not required to publicly update or revise any forward-looking statement whether as a result of new information, future events or otherwise.

Now I will turn the call over to Susan.

Susan Ivey

Good morning. As you saw from the results we announced today, Reynolds American total tobacco business model continues to provide a strong foundation for long-term success. In 2008 we made important gains at both of our reportable business segments with share growth on key brands, margin improvements and additional innovation.

R.J. Reynolds remains focused on strengthening its core cigarette business while expanding its product line and developing new innovations to support future growth. Conwood enhanced its leadership in the moist snuff category with strong volume and share gains and Grizzly ended the year as the nation’s best selling most snuff brand. In addition, our Santa Fe subsidiary fortified its position as the leader in the leading super premium cigarette segment.

RAI’s financial strength was evident in the company’s earnings performance, margin improvement, and upgrade to an investment grade credit rating.

Without question 2008 was a challenging year and this year promises to be even more so with increased legislative and regulatory pressure. But, we have demonstrated that we have the fundamental strength to weather tough times and we’re prepared to not only deal with challenges, but also to take advantage of opportunities that might arise. Our company’s have taken important steps to prepare for the environment that we face. The significant increase in federal tobacco taxes will have a negative impact on industry cigarette volume, however we believe that the industry will continue to have pricing flexibility as demonstrated by the price increases announced last week.

The unprecedented magnitude of the federal tax increase along with a deteriorating economy makes it difficult to predict the impact on volume and earnings. In addition, many states are looking at tobacco taxes to make up revenue shortfalls. We will vigorously oppose tobacco tax increases, but it’s certain that some will pass. We also expect continued efforts to enact federal regulation of tobacco products and as we said before, we do support reasonable comprehensive regulations, that include farm reduction policies, and recognizes the realities of the industries competitive and consumer landscape. But, the legislation that has been repeatedly introduced does not meet those standards and it does not have our support. We remain hopeful that if legislation is passed it will contain meaningful measures that address the significant differences in risks between various tobacco products while providing for a competitive environment that doesn’t disadvantage our companies.

Next I will provide an update on the MPM adjustment.

As you recall R.J. Reynolds has $1.6 billion in disputed MSA payments for 2003, 2004 and 2005. We continue to seek resolution of these disputes through arbitration or settlement with the States Attorney’s General. And, we are encouraged by the fact that 46 out of 48 jurisdictions have now agreed to participate in a national arbitration of the adjustment for 2003. This process should begin this fall. That is an update on the external front. Now let’s take a more detailed look at our business performance in 2006.

R.J. Reynolds delivered higher adjusted margins and earnings and made important progress on a number of fronts. Notably the company strengthened and expanded the offerings and appeals of its flagship Camel brand. In 2008 Camel introduced innovative products like Camel Crush, which has seen remarkable success since its third quarter launch. By offering smokers the option of regular or menthol with each cigarette Camel Crush is adding to Camel’s strength in the menthol category. Last year R.J. Reynolds also announced that Camel will introduce a line of dissolvable tobacco products and that Camel Snus will be launched nationally in the first quarter of 2009.

On Pal Mal, the company refined its promotional strategy which drove higher levels of trial and conversion for this longer lasting cigarette. In the fourth quarter Pal Mal’s share was up almost a full share point over the prior year period. In addition to refining their go to market strategy R.J. Reynolds also reduced complexity and improved productivity in 2008. The company conducted an in depth review of its organization and further streamlined its structure. This restructuring reduces costs and enhances the company’s focus on innovation and initiative to drive growth.

R.J. Reynolds also made significant investments to improve the efficiency and effectiveness of its field marketing organization. These and other efforts position R.J. Reynolds for continued success.

Turning to Conwood, in 2008 our second largest operating company again delivered outstanding results with volume and share gains and higher adjusted margins and profits. Conwood’s Grizzly brand captured half of all the growth in the moist snuff category which grew at a rate of more than 7%. Grizzly’s strength was evident in the performance of its core style and two highly successful styles that were launched nationally last year. Grizzly delivered double-digit volume gains even as the brand raised prices and competitors increased their discounting and promotion. And, the two new pouch styles that Conwood is introducing this quarter should further add to Grizzly’s success.

Kodiac, Conwood’s premium brand, received new packaging and promotional efforts in 2008 and that made the brand more competitive and helped moderate the brands volume decline. Conwood is also developing new, innovative, moist snuff products to improve its position in the premium segment.

As you know, Bill Rosson has stepped down from his position as President and Chief Executive of Conwood. I want to personally thank Bill for the masterful job that he has done in driving Conwood’s growth. I am confident that this will continue under the leadership of Bryan Stockdale, who took the helm at Conwood the beginning of this month. Bill has agreed to stay on for a while in an advisory role to help with this transition and to provide his valuable insight in this time of consolidation in the smokeless category.

Last year Reynolds American also made headway on the responsibility front. We published the first Corporate Social Responsibility report for the entire RAI family and our sustainability efforts were recognized with RAI being named as a member of the Dow Jones Sustainability Index.

So, 2008 was a difficult, but rewarding year. Our companies delivered solid results and took important steps to move our business forward while preparing for the challenges and opportunities ahead.

Now Tom will talk in more detail about our 2008 results.

Thomas Adams

Thanks Susan and good morning. As you heard from Susan, our companies did an excellent job of navigating through 2008. Despite intensified competition in both the cigarette and moist snuff categories our two reportable operating segments increased adjusted earnings and margins. R.J. Reynolds and Conwood improved the marketplace position of their key brands with share gains on core styles and highly successful launches of new products. Reynolds American’s performance in 2008 underscores our company’s strength and resilience even during tough economic times.

Now let’s take a look at our results in more detail. This morning I’ll focus primarily on adjusted results to provide better perspective on our underlying business performance. I would like to remind you that the reconciliation of our adjusted to reported results is in our press release which can be found on our website.

For the fourth quarter RAI’s reported EPS was $0.89 down 11.9%. On an adjusted basis earnings of $1.27 a share were up 10.4% versus the prior year period. For the full year RAI’s reported EPS of $4.57 was up 3.2%.

Reported earnings for 2008 contain several charges including trademark impairment charges of $318 million, restructuring charges of $90 million and a $33 million investment write down. These charges were partially offset by a gain of $328 million from the termination of the Gallaher joint venture. Excluding these items adjusted full year earnings grew 5% to $4.80 a share. Driving this increase were higher cigarette and moist snuff pricing, higher volume at Conwood and increased productivity at R.J. Reynolds. Those factors more than offset lower cigarette volumes and higher settlement expense.

R.J. Reynolds volumes declined 8.4% against an industry decline of 3.3%. The company’s declines are generally higher than those of the industry due to older brands and more price sensitive consumers. However, a number of factors contributed to the company’s higher than usual volume decline in 2008. These included an especially high level of competitive promotion in the first half of the year and the delisting of a number of non-core brand styles.

Not with standing its volume performance last year, the company increased earnings and margins and it gained market share on its two growth brands Camel and Pall Mall.

R.J. Reynolds total market share was down one share point in 2008 as a gain of 8/10 of a share point on growth brands was more than offset by declines on other brands. For the full year Camel grew 3/10 of a share point on the strength of its core and menthol styles. Pall Mall was up ½ a share point as refinements in its promotional strategy increased trial and conversion.

As we mentioned in this mornings release, we directed the vendor that provides R.J. Reynolds with market share data to revise its sampling model beginning this year. As a result we expect to see some adjustment in cigarette share numbers going forward, but we don’t expect any significant changes in trends.

R.J. Reynolds adjusted operating income of $2 billion was 2% higher than the prior year period. The company’s adjusted operating margin of 26.2% was up 1.4% points.

Now I will move on to Conwood. Full year adjusted operating income was $374 million up 8.8% and their adjusted operating margin was up 4/10 of a percentage point at 51.8%.

Conwood’s total volume grew 13.4% over the prior year compared with moist snuff category growth of 7.2%. Conwood’s total share was 27.7% up 1.7% points from the prior year. Driving those results was Grizzly’s outstanding performance which benefited from higher pricing and a volume gain of 18%. Grizzly’s fourth quarter market share was 24.1%. So, Conwood had another great year.

Now I would like to provide additional details on RAI. First I want to underscore RAI’s commitment to returning value to shareholders through our 75% dividend payout target which currently provides and annualized dividend of $3.40 a share.

I would also like to give you an update on our share repurchase program. Last year we bought back $207 million of our shares under the $350 million program that ends in April. We didn’t repurchase any shares in the fourth quarter. Given the current economy and the potential for additional tobacco taxes and regulation we feel it is prudent to preserve liquidity.

Turning to our pension plan, like many other company’s the equity and credit market performance hurt our pension investments last year. Our pension asset returns were down about 30%. That performance will increase our year-on-year pension expense by about $180 million or about $0.40 a share. We are also evaluating our pension funding and will contribute a minimum of $50 million to the pension fund this year.

So, that is an update on several key items.

Now before we take questions, I would like to spend a minute talking about RAI’s capital structure. The company’s fundamentals remain solid. Our strong balance sheet and cash flow position us well in these challenging economic times. Our leverage is low at less than 2x debt to EDIBTA. Our average debt maturity is about eight years and we have an untapped revolving credit facility of $500 million. So, we have no need to access the credit markets to fund operations.

While we did take a $33 million investment write down last year, our cash balance at the end of the year was $2.6 billion with most of that invested in short-term treasuries. So that is an update on Reynolds American’s capital structure.

We are not going to provide a full-year outlook until we can better evaluate the impact of the tobacco tax increases that take effect April 1. Federal tobacco tax increases of this magnitude are unprecedented and they are on top of a recession. As a result, it is difficult to accurately predict the effect on total cigarette volume and pricing, shifts between premium and value priced cigarettes and the level of migration from cigarettes to smokeless products. That’s why we aren’t giving guidance today.

Nonetheless, at this time we do not see a scenario that would require us to reduce our dividend. We do intend to provide a full year forecast as soon as we have more clarity on these issues. I will point out though, that as a total tobacco company with strong entries in the premium and values segments RAI is well positioned to benefit from any shift across tobacco categories.

In closing, we are very pleased with RAI’s accomplishments in 2008 including the steps we took to prepare ourselves for the challenges and opportunities of 2009.

Thank you and now we will turn the Q&A portion of the call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Judy Hong with Goldman Sachs

Judy Hong - Goldman Sachs

Susan, I know there is a lot of uncertainties out there and you’re not giving specific ’09 guidance, but I’m just wondering if you can give us some perspective as we think about the tax increases. If we compare this period versus some of the years in the past where there’s been significant price increases do you think the price elasticity factor could be more different this time around than in the past? As the price gap narrows between the premium and the discount do you think that the premium will hold up in this environment? I’m just trying to get some perspective on those issues.

Susan Ivey

I think, Judy that actually you’ve hit the nail on the head as to why we’re not giving specific guidance, but let’s think about the environment. A lot of people have tried to liken this tax increase, for instance, back to the MSA. That was the last time there was a large national price increase. The environment today is very different though on a couple of fronts. Obviously the economy is in a very different situation and so how consumer behavior will or will not change will be very interesting. Fortunately this tax is on all cigarette products, so the MPMs will not have any distinct advantage.

We also are in a situation where for the last five to seven years the smokeless category has been growing at 6% to7% a year. There are a lot of dual users in the smokeless category and actually the price gap between smokeless and cigarettes will grow with this tax increase; so will consumers migrate at an accelerated pace to moist snuff or other smokeless product like Snus, like Dissolvables?

I think we’re in a different situation today. We have always said from the time of the merger that we felt it was important in R.J. Reynolds business to have a strong value brand, because economics can change and Pall Mall has certainly demonstrated, in 2008, it’s strength in this category, growing almost a sheer point quarter-over-quarter a year ago. So, I think it is different because we could see more movement across categories. You also have differential taxes. So, roll your own now becomes tax equivalent to cigarettes and so will those people move to value manufactured cigarettes? Where will they go?

I think there is more in motion. We believe that the consumers will be in motion. We believe that our companies as a group are prepared to benefit from being in motion, but obviously we also don’t lead the pricing environment. There are a lot of things in flux, but we are confident that we will weather through this. We just don’t want to, I think as somebody else said, we don’t want to go down the slipper slope of proving guidance and being wrong.

Judy Hong - Goldman Sachs

Okay and just in terms of your perspective, Susan, as you think about potential decline in volume, your volume is already declining above the industry rate. How are you prepared to offset maybe more accelerated volume decline whether through even more accelerated cost savings initiatives or maybe even thinking about your brand portfolio a little bit differently and repositioning some of your perhaps non-growth brands and repositioning their price points to attract more value consumers?

Susan Ivey

Well obviously we are always evaluating the environment. I think that R.J. Reynolds certainly has demonstrated that continuous productivity is a way of life in that organization and last year we took steps to restructure and streamline that organization in preparation for the conditions that we may face this year. So, I am confident that we are ready. I am confident that we will make the right decisions with the brand portfolio as we see consumers go into motion.

Judy Hong - Goldman Sachs

Okay and then just to clarify on pension. Tom, you said $180 million incremental which is $0.40 to earnings.

Thomas Adams

Of expense, that is correct, at $50 million of funding. The $180 million, I would just remind you, is not cash. The $50 million is cash.

Judy Hong - Goldman Sachs

Right, but from a P&L perspective that seems like a pretty big drag to your earnings in 2009.

Thomas Adams

It’s a [inaudible] number.

Judy Hong - Goldman Sachs

Okay and just in the fourth quarter your SG&A expenses were down pretty meaningfully. Can you just maybe walk through what drove that improvement on some of the SG&A side?

Thomas Adams

Part of it was the cost savings and restructuring that we announced in September and that began to build in the fourth quarter and we’ll see the benefits of that largely beginning in 2009.

Judy Hong - Goldman Sachs

Okay. Any early read in terms of some of those markets where US tier or Ultra smokeless tobacco business has not stepped up promotional spending in those southeast markets and what kind of impact that’s having on Grizzly?

Susan Ivey

Obviously we will watch that very closely. It’s too early to tell. Grizzly grew last year, again took more than half the industry growth, and then grew 2.2 share points. It grew in 49 out of 50 states and Grizzly is benefiting from this economy. It’s a fabulous product at a great price point and it has very strong equity. So we will certainly monitor that, but that price gap has closed every year for the last three as they have increased promotional spending and we have taken pricing. We are very confident that Grizzly will prevail in this environment.

Operator

Your next question comes from Steve [Oweirda] with Credit Suisse.

Steve [Oweirda] - Credit Suisse

Good morning. Can you give me an average of what the Grizzly sales price is in the country right now?

Susan Ivey

$2.35.

Steve [Oweirda] - Credit Suisse

Your press release talked about price gaps in the smokeless category coming down further probably during the year. Do you have an idea at what price gap the growth for Grizzly could become more difficult?

Susan Ivey

Well I think, obviously, watching that price gap is important, but the price gap is still very meaningful and I would say it has a long way to go to remain meaningful. I wouldn’t disclose any competitive research that we might have, but we remain confident in Grizzly’s resilience. It’s a great product at a great price. It has grown from 0 to 24 share points in seven years. So, I think that demonstrates the equity that it has built and the popularity. It is the largest moist snuff brand in the country in the fourth quarter.

Steve [Oweirda] - Credit Suisse

The cigarette portfolio, the market share losses for the cigarette portfolio slowed down during the year after a fairly dramatic first quarter. Is that a full year trend that was driven by the first quarter being so negative for the market share or is that a trend that we should expect to continue for fiscal ’09?

Susan Ivey

I think after the very heavy promotional activity in the first five months of last year when the competitive environment kind of stabilized, if that’s possible, then you saw the overlying performance and the sequential improvement really, I think, reflects the strength of the brand. Camel Crush was very successful for the Camel brand and we believe that will continue to grow and Pall Mall, I believe, it benefiting from the economy and it, again, is a longer lasting, high quality cigarette at a value price.

Pall Mall, as I mentioned before, grew substantially last year. Where we only saw the NPM, you know the low-end guys take back about 3/10 of a share point. Pall Mall grew a full share point quarter over quarter in the fourth, so we believe that we have a good handle on the brand portfolio and that those trends will continue.

Steve [Oweirda] - Credit Suisse

Should we expect to see any changes to your cigarette portfolio this quarter similar to the ones that you did in the first quarter of ’08?

Susan Ivey

In the first quarter of ’08, if you are referring to Kool moving to support, Kool did move from being a growth brand at Reynolds to being a support brand, which means that we are still supporting it through discounting to retain the franchise, but we are very pleased and believe that Camel and Pall Mall in that growth portfolio are the right brands and are demonstrating the appropriate growth.

Steve [Oweirda] - Credit Suisse

I was more referring to discontinuing some of the smallest brands or some of the smaller line extensions.

Thomas Adams

Yes, actually we’ll continue to do that through out the year as we try to rationalize our RSKU [inaudible] and actually grow some of the volume declines in addition to the comments that Susan had, because we began delisting these things towards the back half of 2007. So we saw the absence of those shipments occurring in the early and the first part of 2008, even though the market share was still there, because of the sell through of those inventories.

Steve [Oweirda] - Credit Suisse

I was a little bit surprised to see that the premium contributions for the entire industry in cigarettes actually improved in the fourth quarter bucking the trend for the full year. Can you give us a little bit more background on why you think that is the case? I would have expected to see down trading this quarter actually.

Susan Ivey

I think there was significant promotion in the fourth quarter. I don’t have a lot to say about that actually. I think consumers, tobacco has proven to be relatively resilient, and we are really sort of in that consumer staple category and with the right promotional offers smokers are making their choices.

Operator

Your next question comes from David Adelman with Morgan Stanley.

David Adelman - Morgan Stanley

Susan, when you look at the outlook over the next 12 months for R.J. Reynolds, what is the greatest relative source of uncertainty? Is it the pricing that your competitors will put in the market? Is it the overall impact on cigarette industry volumes? Or is it the inevitable relative disadvantage of your brand portfolio given its dynamics in that environment? How would you rank those factors?

Susan Ivey

I think, as you referred, we are not the price leader in premium and so the pricing and how the pricing structures to recover some of the volume losses is an uncertainty for us. I’m confident in our brand portfolio strategy. Certainly predicting volumes in the context of category movement is another relative unknown. I described that before when I answered Judy’s question. We are in a different market place and consumers in motion, particularly across RAI, I think it’s difficult to predict exactly where consumers will go. But, certainly the pricing plays a major role.

David Adelman - Morgan Stanley

As a follow up to that, if PM USA and Lorillard’s underlying profitability in 2009 is down say 2% in aggregate, what would be acceptable or expected operating performance for R.J. Reynolds in that environment?

Susan Ivey

David, I’m not going to go there. Then I would be giving guidance.

David Adelman - Morgan Stanley

What I am trying to understand is your sense of the relative performance you’d expect from that business versus your peers in a stressed environment.

Susan Ivey

Well I think we continue to look at this business also across all of our operating units and we look at total tobacco. I would look to see how the movement of consumers and earnings is moving across those businesses. Reynolds also has made a big commitment to launching Snus nationally this quarter. I think that’s very good timing, giving smokers alternatives in a new tax environment. The Dissolvables are on the front end giving them other ways to enjoy tobacco pleasure. So, I think we have to see how this unfolds. I really am not prepared to give a compare.

David Adelman - Morgan Stanley

What is the likelihood or the prospect of the industry essentially getting a windfall level of profitability in the first quarter as fairly substantial price increases presumably are going to be phased into the marketplace before the April 1 effective date of the FET increase? I mean essentially there have been two price increases just since December.

Susan Ivey

Well I think you also have to think about those price increases and how if you raise list or reduce discounting, have you spent that back? I think it is wise to be careful saying there have been a lot of price increases. The net pricing, certainly we have seen some net pricing and certainly the pricing that was announced last week is certainly out in front of the FET tax which has to be taken, obviously, by April 1. Again, it very much depends on how those moneys are used or not used to support promotional programs and this has to unfold.

David Adelman - Morgan Stanley

Okay and on the state excise tax outlook, are you encouraged or how encouraged are you by the fact that there has not been, to date, to my knowledge, a state excise tax increase? At what point during the year do you start really narrowing the likely range of outcomes of weighted average state excise tax increases for ’09?

Susan Ivey

That is a good question, David. I mean, I think there is 18 states or something at this stage that are looking at cigarette taxes. What we don’t know, I mean none of us know in the country, will the stimulus package help offset some of these state deficits? Does the SCHIP money, which is now being collected at the federal level, does that offset some of the states other expenses? Certainly we are working hard to educate the states that increasing state taxation on top of federal taxation has a reducing return potential. So, we will continue with that education.

It is certainly too early to say, as I refer, certainly some states will take tax increases, but I think that’s another open issue in this economy that is harder to predict this year than others.

David Adelman - Morgan Stanley

What fraction of the promotional spending increase on Copenhagen and Skole for ’09 do you envision already in the marketplace versus what’s to come?

Susan Ivey

David, honestly I can’t give you a fraction. Certainly the announcements about testing in the number of states and increasing the promotional levels there, there are a lot of different gaps in prices across those states and there is a lot of learning to be done. We saw UST prior to the consolidation continue to increase promotional spend and we continued to see Grizzly grow. We will continue to monitor the situation, but as I have said a number of times, we are very bullish on Grizzly’s equity and resilience.

David Adelman - Morgan Stanley

Great and Tom, am I correct that on the pension side in the absence of a very large scale contribution and in the absence of sort of outsized favorable pension returns going forward that the rate of P&L pension expense in ’09 is likely to persist for the next couple of years? Is that a correct statement?

Thomas Adams

I actually haven’t looked at 2010 and 2011. I would expect that with the contribution that that may happen, but I’ll have to look at that and get back to you on that.

Operator

Your next question comes from Erik Bloomquist with J.P. Morgan.

Erik Bloomquist - J.P. Morgan

I was wondering if you could talk a little bit about the regulatory front and FDA and in particular what the prospects are for alternative versions of FDA regulation. I mean are those things that have been drafted and are being kicked around or do we have quite a long ways to go for a viable alternative to say the current Waxman FDA proposals?

Susan Ivey

Actually I am encouraged about the potential for an alternative regulatory package. We have said many times that a package that is cognizant of informing consumers about the differences in risk across tobacco categories and protects a competitive environment is very important to us. I still feel confident that an alternative regulatory package is achievable and we’ll have to see how this unfolds.

Erik Bloomquist - J.P. Morgan

Okay, but are there any markers that we should be looking for in terms of being able to track that and gain additional confidence that that’s something that is potential as opposed to the Waxman version?

Susan Ivey

I really don’t have an answer to that, but I can confirm to you that we will certainly keep you posted and we will make ourselves and Tony available to discuss the developments on this regulatory front as they evolve.

Erik Bloomquist - J.P. Morgan

Okay thank you. Then, with respect to the outlook for the smokeless category, will the launch of the mint and straight styles in Grizzly, will that help mitigate some of the difficult H1 comparisons that we have from last year on the prior Grizzly new launches? Is that a correct way to characterize how the growth will be with weakened H1, stronger in H2? Then are you still comfortable, in general, with category growth in the mid-single digits?

Susan Ivey

I would say yes, that we have not seen any slowing down in the growth of the category 7.2, 7.3. I mean that’s really what we saw in ’08 and no slowing down. The pouch segment has grown quite substantially like up 20%. Now it is still not a dominant share of the moist category, but I think that your assessment is right. We are lacking launches and then that will then contribute to the full year growth, but we had very strong success with wintergreen pouches and we are seeing good early signs on mint and straight.

Erik Bloomquist - J.P. Morgan

Okay fabulous. Last question then, can you just give us an update on what you saw with Camel Snus in the quarter prior to being launched nationwide? But, have you seen people taking that on as a dual use product or is there any sense that there are people who are switching to that product entirely?

Susan Ivey

Good questions, Eric. I would say that we continue to see that Snus is primarily attractive to smokers. Smokers are using Snus when they can’t smoke. The longer Snus’ in the market, we do see growth in the use of Snus substituting smoking occasionally. So, we have seen builds in the markets for Snus where we have been for a longer period of time with increased off take on Snus.

As I said, we are very encouraged by that, because again, as the tax scenario will again provide additional pricing incentive for smokers to try Snus. That’s certainly part of our migration strategy.

Operator

Your next question comes from Ann Gurkin from Davenport & Company Llc.

Ann Gurkin - Davenport & Company Llc

I have a couple of questions regarding the smokeless category. I was late getting on the call, so I apologize. Did you comment on your outlook for performance of the moist smokeless overall category in 2009?

Susan Ivey

Well we didn’t really specifically say that, but we don’t believe it will slow down and we also described an unknown situation. There are seven million users of moist snuff today and quite a large proportion of them are dual users. If the significant increase in cigarette tax entices them to switch solely to moist we might see a different growth pattern. We just really don’t know in this environment how the category interface will work with the new tax structure.

Ann Gurkin - Davenport & Company Llc

Okay and in the release you talk about Conwood’s strength and you expect it to continue to be successful. Can you define what you mean by success? Is it market share? Is it volume? Is it profitability? Can you give a little bit more detail?

Susan Ivey

Well it is all of the above. They have delivered all of the above, certainly since they have been part of the RAI family, and we continue to see that in the future.

Ann Gurkin - Davenport & Company Llc

Okay and then you commented a little bit, Susan, about the steps you have taken in the cigarette business to right size capacity. I just wanted to go through it again. The steps you took in terms of improving capacity in the cigarette business, when you took those steps did you factor in a severe drop in volumes this year? In other words facing a higher tax environment?

Susan Ivey

Certainly as we, I’m not sure Ann where you are [interposing] factoring?

Ann Gurkin - Davenport & Company Llc

I guess are you factoring in double-digit volume drops in the cigarette business in 2009 in light of the higher taxes when you right sized your capacity last year?

Susan Ivey

When we right sized the organization we certainly were looking at the potential for an FET increase. We feel as a result of that restructuring that we are prepared. This tax is not a surprise. We just don’t know exactly how the consumer dynamics will unfold, but yes, certainly we considered that.

Ann Gurkin - Davenport & Company Llc

Okay great. Then can I get an update on the Star scientific case, where we are with that?

Susan Ivey

Ann, if you don’t mind, we could get back to you with that offline.

Ann Gurkin - Davenport & Company Llc

Okay, that’s fine.

Susan Ivey

There are no developments. I mean there’s nothing to say. I just don’t have all of the information in front of me.

Ann Gurkin - Davenport & Company Llc

Okay, that’s fine, thank you.

Operator

Your next question comes from David Winters with Wintergreen Advisors.

David Winters – Wintergreen Advisors

You now one of the things that strikes me in listening to Wall Street asking questions is that they never seem to give the company credit for what an amazing job you all have done since the merger. Good acquisitions, it’s just I don’t know. The shares perennially trade at a discount, yet you do a great job.

My question from my perspective, you are doing a lot of things on, sort of, innovative products whether you call them dissolvables, you have done some things with Camel to make it turn into a menthol cigarette and others. Can you just talk a little bit about the innovation and also what regulation might do to slow that down, because that’s potentially a whole avenue of future cash flow that folks don’t look at, at all?

Susan Ivey

Thank you, David. I would be delighted to talk about that. As you have referred, innovation is core to our strategy, because this is about understanding changing consumer preferences, consumer’s desires to enjoy tobacco pleasure in a different way. Our company’s are focused on incremental innovation like the Camel Crush product and significant innovations that could change the market dynamics. Certainly this is part of a holistic strategy that will drive future earnings growth.

These products, certainly the smokeless products, the dissolvable products and the Snus products are better for public health and will provide better margins in cigarettes going forward. So, it is not just innovation for innovations sake. It is innovation to drive future sources of revenue. I think that here to for people have under estimated the potential of growth. Now nobody knows how fast these segments could grow, but you know I have given the examples of the tax environment, could accelerate this kind of migration.

In terms of regulation certainly the FDA bill that’s been floating around could slow down innovation, but we feel very comfortable that we are out in front. That we have products in these lead markets that are consistent with current things on the market and that we lead the way in this new modern, smoke free category. We very much see it as replacing cigarette earnings over time and without taking a longer-term perspective we would not be serving the shareholders well.

David Winters – Wintergreen Advisors

Is there any change in the status with BAT?

Susan Ivey

No, there is no change. They are a 42% holder and we continue to have a good relationship.

David Winters – Wintergreen Advisors

Well thank you and good luck in the choppy waters ahead, but you have been a wonderful Skipper.

Susan Ivey

Thank you very much David. I appreciate your support.

Operator

Mr. Moore it appears we have no further questions. At this time I would like to turn the conference back over to you for any additional or closing remarks.

Morris Moore

Thank you again for joining us. A replay of this call will be available on our website at reynoldsamerican.com until March 13.

Operator

Thank you ladies and gentlemen. Once again, that does conclude today’s conference. We thank you for your participation.

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Source: Reynolds American Inc. F4Q08 and Full Year Earnings Call Transcript
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