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Reynolds American Inc. (NYSE:RAI)

Q4 2009 Earnings Call

February 4, 2010 9:30 am ET

Executives

Susan Ivey - Chairman & Chief Executive Officer

Tom Adams - Chief Financial Officer

Morris Moore - Vice President of Investor Relations

Analysts

Judy Hong - Goldman Sachs

David Adelman - Morgan Stanley

Adam Spielman - Citigroup

Marc Greenberg - Deutsche Bank

Ann Gurkin - Davenport

Thilo Wrede - Credit Suisse

Operator

Good day and welcome to today’s Reynolds American fourth quarter 2009 earnings call. As a reminder this call is being recorded. At this time, for opening remarks and introductions I would like to turn the call over to Morris Moore, Vice President of Investor Relations; please go ahead, sir.

Morris Moore

Good morning and thank you for joining us. Today we’ll discuss Reynolds American’s results for the fourth quarter and full year as well as our outlook for 2010. We’ll discuss our results on both a reported and adjusted basis. A reconciliation of reported to adjusted earnings is in our press release, which is on our website at www.reynoldsamerican.com.

Joining me this morning are RAI’s Chairman and CEO, Susan Ivey and our CFO, Tom Adams. Before I turn to call over to Susan I need to cover the Safe Harbor provisions. During the call we’ll 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 detailed in our press release and our SEC filings. Except as provided by Federal Securities Laws, we’re not required to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. I would also like to remind you that we now use RAI’s website as a primary source of publicly disclosed news and we encourage investors and others to sign up for email alerts.

Now I’ll turn the call over to Susan.

Susan Ivey

Good morning. As we detailed in this morning’s release, Reynolds American continued to exhibit strength and resilience in 2009, despite many economic and industry challenges. Our operating companies continued to demonstrate momentum, with volume and share gains on key brands and additional improvements in productivity.

Our earnings were down last year, driven by the negative impact of a significant increase in pension expense. Nonetheless, our strong underlying performance clearly shows that the fundamental strategies and strengths of RAI and its operating companies continue to serve us well. To understand where we are today, let’s look back at where we were, this time last year.

On the economic front, we started the year in a deep recession, with high unemployment that depressed consumer spending and specific to the Tobacco industry, we saw unprecedented increases in federal tobacco excise taxes, which led to the retail price of a pack of cigarettes increasing by about 25%.

In addition, the moist-snuff category underwent major changes. The acquisition of Conwood’s largest competitor resulted in significant price reductions on premium moist-snuff. There were also substantial increases in the competitive promotional levels for both premium and value priced products. In addition, the industry entered a new environment, and FDA regulation of Tobacco products has added complexity to our company’s operations.

Despite these challenges, RAI continued to return value to shareholders in 2009. We increased our dividend by 6%, and delivered a total shareholder return of 43%, far outpacing the S&P 500. Given the proven strength of RAI’s business model, our company’s key brands, and ongoing efforts to enhance productivity, we expect earnings growth to return to the mid-single digits in 2010.

Let’s take a closer look at some of the year’s highlights. R.J. Reynolds strengthened growth brand performance with Camels’ continued evolution into a total tobacco brand and Pall Mall becoming the fourth largest cigarette brand in the nation. The company also continued to improve productivity and strengthen margins.

However, adjusted operating income declined due to higher pension expense. Conwood again delivered outstanding performance in what was among the most challenging years it has ever faced. The company posted strong gains in moist-snuff volume and share with Grizzly enhancing its equity and increasing its lead as the number one moist-snuff brand and Santa Fe continue to deliver great results last year with double-digit volume growth in the super-premium segment, and the largest gain in cigarette share in the company’s history.

Also during 2009, RAI entered a new product category with the acquisition of Niconovum AB. Nicotine-Replacement therapy products are a small category with good potential for future growth. These products also align with public health objectives. Like RAI’s other companies, Niconovum strength is in its superior technology and innovative products that will offer more you appeal to consumers than existing products.

Over time Niconovum plans to expand its product line and enter additional markets. At Conwood, the company announced that its name would change to American Snuff Company at the beginning of this year. This returns the company to the name it started with in 1900, reinforcing American Snuff Rich Tobacco Heritage and its commitment to delivering the highest quality tobacco products to adult tobacco users.

Finally I would like to note that RAI again received independent recognition for its sustainability and responsibility initiatives. The company was awarded membership in the Dow Jones Sustainability North American index, for the second year running and RAI was ranked in the top half of the company’s featured in Newsweek’s first Annual Green Rankings. So those are some of the ways that RAI and its operating companies demonstrated strength and resilience in 2009.

Before I discuss our business performance in more detail, I’ll provide a brief update on the external front. RAI and its operating companies are making good progress to ensure compliance with the new FDA regulations. While we await additional details from the agency, we are prepared to compete effectively as new requirements take effect over the next several years.

As you know, R.J. Reynolds, Conwood and others sued the government over certain provisions of the new regulation on issues surrounding free speech. The judge in the case has since ruled that the ban on the use of color and graphics in marketing is unconstitutional. On the MPM adjustment, we currently have a total of $2 billion in dispute, covering 2003 through 2006. The arbitration process to resolve the dispute over R.J. Reynolds 2003 MSA payment is still underway.

So, now let’s take a more detailed look at our operating company’s performance for 2009. Although increased pension expense weighed on R.J. Reynolds earnings for the year, the company delivered strong underlying results. R.J. Reynolds increased its overall growth brand share, improved its cigarette volume performance and continued to improve productivity. The company’s total cigarette share has been relatively stable for the past two years, at just over 28%.

Contributing to that were additional combined gains on growth brands, which now represent almost half of the company’s total cigarette market share. During the year, R.J. Reynolds moderated its volume decline, bringing it inline with the industry rate. They achieved this even as the company eliminated a significant number of its non-core styles, and many low margin private label brands.

Camel, the company’s flagship brand, improved its marketplace position as a total tobacco brand with stable share in cigarettes, and gains in modern smoke free products. Camel continued its focus on building the brand’s core cigarette styles, discontinuing five additional non-core styles, without adding any new line extensions last year. Even so, Camel delivered steady share, significantly outpacing the overall share performance of the industry’s premium segment.

Camel Crush, the brand’s most recent cigarette innovation, performed well in its first full year, with relatively low levels of promotional support. Crush gives adult smokers the unique choice of regular or menthol with each cigarette. R.J. Reynolds focus on Camel in the menthol category increased the brand’s total menthol share, in this growing segment in 2009, and the company expects further growth from the recent expansion of its innovative capsule technology to Camel’s two core menthol styles and next month the company will add exciting new packaging to further raise awareness and competitive trial on these menthol styles.

Camel’s focus on strengthening its core cigarette business is a key part of the company’s strategy to grow Camel as a total tobacco brand. The strategy includes broadening the brand, to offer innovative modern smoke-free products like Camel Snus and Dissolvables as well as Conwood’s Camel Dip.

Camel’s first smoke-free innovation, Camel Snus was launched nationally early last year and it’s already contributing to Camel’s total tobacco share. Camel Snus significantly outsells competitive products in the markets where they compete. However, because this is a new category in the U.S., consumer education is a key to building awareness and trial, and this takes time.

Camel’s latest smoke-free innovation, Camel Dissolvables entered three lead markets this year and R.J. Reynolds is gaining valuable insights that are being incorporated to improve both the product and the packaging design. Camel Orbs, Sticks and Strips are made of finely-milled tobacco, that completely dissolved in the mouth and they offer adult consumers the most convenient way to enjoy tobacco today.

Turning to Pall Mall, R.J. Reynolds’ other growth brand. Pall Mall delivered outstanding growth in 2009, with strong gains in both volume and share. Like many other value brands, Pall Mall sells for an affordable price, but it differentiates itself by offering a high quality, longer lasting cigarette.

Because of that difference, Pall Mall retains about half of the adult smokers, who give it a try and Pall Mall’s promotional strategy has generated significant awareness and trial for the brand. Weakness in the economy also drove an increasing number of adult consumers to seek greater value in the products they buy, and this benefited Pall Mall.

Also during 2009, R.J. Reynolds continued to reap the benefits of its tight focus on productivity, cutting additional non-focus styles, eliminating non-essential activities, and outsourcing non-core business activities. In addition, the company streamlined its workforce to keep staffing and cost inline with business needs. These productivity initiatives helped R.J. Reynolds again increase its full year adjusted operating margin. R.J. Reynolds added strength in 2009, and I’m very pleased with its performance in a very challenging year.

Turning to Conwood, Conwood has delivered outstanding performance, since RAI acquired the company in 2006 and its performance in 2009 was no different. The company posted strong gains in moist-snuff volume and share, despite a very difficult environment.

The moist-snuff category saw major changes last year, with significant increases in both federal and state excise taxes. In addition, Conwood’s largest competitor significantly reduced the price of its premium products. Conwood’s competitors also heightened promotional spending on their premium and value price products. Even so, Conwood delivered impressive results, with Grizzly driving strong gains in moist-snuff volume and share. The company now commands almost 30% of the moist-snuff market.

While Conwood’s adjusted operating income was down for the year, this decline was primarily driven by lower margins on the company’s premium Kodiak brand. Conwood reduced the brand’s price in the second quarter to bring it inline with competitive premium brands. It’s also important to note that Conwood increased its adjusted operating margin for the year, as it benefited from higher volume and a price increase on Grizzly, as well as higher pricing on its other products.

Grizzly delivered exceptional performance in 2009, capturing almost 70% of total moist-snuff growth. Despite intense pricing and promotional pressures, the brand further enhanced its position as the nation’s leading and fastest growing moist-snuff brand, with a full year’s share of more than 25%.

Grizzly also strengthened its position in the growing pouch segment, which it entered in 2008. At the end of last year, Grizzly had introduced four successful pouch styles and Grizzly Wintergreen pouches became the category’s number one pouch style. In less than two years, Grizzly has gained almost 20% of the total pouch segment.

Conwood is focused on adding even more value and equity to the Grizzly brand, with embossed metal lids being introduced this month. The brand is also introducing Grizzly 1900 Long Cut, a natural product with a traditional cut that will broaden Grizzly’s appeal amongst moist-snuff consumers.

Conwood is also enhancing its strength in the premium moist-snuff segment. Reducing Kodiak’s price last year has helped to improve the brand’s performance and stabilize its share and Kodiak is now upgrading its image with new packaging that also features metal lids. Camel Dip, Conwood’s latest premium introduction, features product and packaging innovations. The brand is generated very encouraging consumer response since its mid year introduction into two week markets.

Camel Dip is being expanded to 10 additional states this month, along with the launch of the brand’s third style, Camel Wintergreen pouches. Given Conwood’s continued strength last year, I am confident that the company’s focus on building volume, share, brand equity and profitability positions them well for 2010. So that’s a look at Reynolds American’s many accomplishments in 2009, despite, an especially challenging year for both the industry and the economy.

Now, Tom will provide you some more details.

Tom Adams

Thank you, Susan, and good morning everyone. As you’ve heard today, RAI and its operating companies improved their underlying performance in many key areas in 2009. During my discussion, I’ll focus on adjusted results to provide perspective on our underlying business. Reconciliations of adjusted to reported results are in our press release, which is on our website.

First, I’d like to remind you, that our full year earnings include $189 million in higher year-over-year pension expense. Primarily at R.J. Reynolds, that comes to $0.10 per share for the fourth quarter and $0.40 per share for the full year. This additional cost drove a negative earnings comparison in 2009.

Let’s look in more detail at RAI’s results, starting with the fourth quarter. Reported EPS of $0.74 was down 15.9% from the prior year. This includes $0.36 in restructuring charges and cigarette trademark impairments at R.J. Reynolds.

On an adjusted basis, excluding restructuring and trademark impairment charges, fourth quarter EPS of $1.10 was down 13.4% from the prior year period. That was primarily due to increased pension expense as well as a decline in Conwood’s earnings due to lower premium margins and higher promotional expense.

Full year reported EPS was $3.30, down 27.6% from the prior year. This decline was primarily the result of net increase of $0.47 in restructuring and non-cash trademark impairment charges, as well as a prior year gain of $0.71 from the Gallaher joint venture termination.

On an adjusted basis, excluding restructuring and trademark impairment charges and the JV gain, full year EMS of $4.64 was at the midpoint of our guidance range of $4.60 to $4.70. Adjusted EPS was down 3.1% from the prior year, driven by higher pension expense.

Now, turning to R.J. Reynolds, in the fourth quarter, higher pricing and productivity were largely offset by lower cigarette volume. The company’s fourth quarter adjusted operating income of $487 million was down 9.8%, primarily driven by higher pension costs. For the full year, the benefit of higher pricing and productivity and lower promotion expense more than offset the impact of lower cigarette volume.

However, full year adjusted operating income of $2,034,000,000 was down 1.4%, again, driven by higher pension expense. R.J. Reynolds’ productivity initiatives contributed to a 1.1 percentage point increase in its adjusted operating margin. Full year adjusted operating margin was 27.7%. Cost savings from restructurings in 2008 and 2009 will grow to about $60 million this year, building to an annual savings of $75 million in 2011.

Now turning to volume, R.J. Reynolds’ total cigarette volume declined 8.7% last year, compared with the industry decline of 8.6%, a marked improvement from the company’s historical trend. With respect to cigarette market share, R.J. Reynolds’ full year share was essentially flat at 28.3%, as overall growth brand gains largely offset declines in support and non-support brands. R.J. Reynolds total market share has been relatively stable over the past two years, and 2009 performance was its best since the merger with Brown & Williamson in 2004.

The company’s growth brands, Camel and Pall Mall, delivered a combined full year cigarette share of 12.3%, up 1.9 share points from the prior year. This improved performance was driven by strong growth in Pall Mall. Camel cigarette market share for the full year was 7.5%, down one-tenth of a share point. However, Camel’s total tobacco market share grew to 7.8%, as cigarette equivalent share of 0.3% from Camel Snus more than offset the slight decline in Camel cigarettes.

Turning to Pall Mall, Pall Mall grew 2.1 share points to 4.8% in 2009, as the brand continued to retain roughly half of the volume it gained from its promotions. So those are the R.J. Reynolds key results.

Now, turning to Conwood, Conwood’s fourth quarter operating income was $83 million, down 16%. Grizzly’s volume and pricing gains were more than offset by lower margins on Kodiak, as well as support for the introduction of Grizzly Snuff Pouches, and increased promotional spending in several states. For the full year, Conwood’s adjusted operating income, excluding trademark impairments, was $352 million, down 6%, primarily due to lower premium moist-snuff margins. The company’s full year adjusted operating margin increased half a point to 52.3% from the prior year.

Turning to moist-snuff volume and share, Conwood’s total shipment volume grew 6.4% for the year, well ahead of the industry’s growth of 4.4%. Grizzly’s full year volume increased 8.9% despite significant pricing pressure from both premium and value brands and the brand also posted a strong share gain of two share points, bringing Grizzly’s share to 25.3% for the full year. Conwood’s total share was up 1.8 share points at 29.4%. So that’s a quick look at the considerable progress that R.J. Reynolds and Conwood made in 2009.

Now some additional details on RAI, Reynolds American maintained a strong balance sheet in 2009, ending the year with cash balances of $2.7 billion and that was after contributing $300 million to the pension plan, repaying debt of $200 million, and acquiring Niconovum for $43 million. Like many companies, our pension assets were negatively impacted by the market turmoil in 2008.

In addition to last year’s contribution to the pension plan, we added an additional $300 million in January of this year. These contributions, together with the return of almost 25% last year, have significantly increased the plan’s funded position. I would point out that our pension expense projections for this year are inline with 2009. Other uses of cash this year include repayment of debt and capital spending for the expansion of Conwood’s production facilities, to keep pace with growing demand and these new facilities will be FDA compliant.

With respect to our dividend, RAI increased its quarterly dividend by $0.05 per share to $0.90 or $3.60 on an annualized basis. This reaffirms our confidence in the business, and our commitment to our shareholders. The increase is also inline with RAI’s policy of returning about 75% of net income to its shareholders in the form of dividends. So looking ahead, we expect our operating companies to build additional strength this year, which supports our return to mid single-digit earnings per share growth in a range of $4.80 to $5. Thank you.

We’ll now turn to the Q-and-A portion of the call. Jennifer, would you please remind our callers how to get in the queue?

Question-and-Answer Session

Operator

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

Judy Hong - Goldman Sachs

Susan, I guess first question on the cigarette side. I’m trying to just better understand your strategy and really focusing on growing Pall Mall. Clearly, you are getting a good volume lift as you put in the higher promotions behind the brand, but your overall mix is now declining. Your profitability even if you adjust for the higher pension doesn’t appear to be growing as much as some of your competitors. So I’m just wondering why this is an effective strategy from your standpoint?

Susan Ivey

Yes, sure Judy. I think we’ve talked for years about our focus on the growth brand and the growth brands are very clearly for R.J. Reynolds Camel and Pall Mall. So I would say we remain very focused on Camel, and expanding Camel as a total tobacco brand. It has a strong demographic profile and we haven’t taken the pedal off of Camel in anyway.

With Pall Mall, I believe that we have said also for five years that having a strong value brand in the mix was appropriate in an industry and an environment at a point in time and if we think about what happened last year, the economy is in a significant recession, unemployment levels are still rising, and cigarette smokers experienced a 25% increase in their daily expenditures. Pall Mall differentiates itself in the value space.

As I said in my remarks, it is a high quality, longer lasting cigarette and we believe that growing Pall Mall, we saw the non-big three last year grow about six-tenths of the share point. “What would that sector have grown had Pall Mall not been in the arena?” Because consumers are clearly interested in honest value, despite that, R.J. Reynolds grew its operating margin year-over-year. We believe that our productivity will continue to deliver results in that operating margin area, and Pall Mall has been successful and we believe it still has more runways.

Judy Hong - Goldman Sachs

Just following up on that, so if we assume that post you lap the April pricing increases last year and the industry returns to more normalized environment, do you think that Pall Mall’s growth can continue at the rate that we’ve seen in 2009, absent another additional step up in terms of the promotional spending?

Susan Ivey

I think we spent into the tax increase and we did that quite specifically. The current rates of promotion on Pall Mall, which is different, in different geographies, do not mere the rates that were during that FET. However, we do still expect Pall Mall to grow because we believe the proposition continues to demonstrate its strength. As people try Pall Mall, we get about a 50% conversion to the brand, and the brand is becoming increasingly popular. So I do expect it to still grow, but it won’t be at the rates we saw last May.

Judy Hong - Goldman Sachs

Then on the smokeless side, can you just share with us from your perspective what kind of effect that you think that the Wintergreen launch is having on Grizzly and does that make you think about maybe stepping up on the spending more on Grizzly to defend share in that marketplace?

Susan Ivey

Well, I think the results in ‘09 clearly demonstrate the strength of Grizzly. There was a lot of promotional activity in the moist-snuff segment in the fourth quarter, certainly one of those was Copenhagen Long Cut Wintergreen and we also saw a lot of promotion at the bottom end of the market as well.

Grizzly I think performed very, very well. Our current view is that Grizzly is currently donating much less than half of its fair share to trial of Copenhagen Long Cut Wintergreen, but it’s very early days. I believe Grizzly’s product is superior. I believe its equity is exceptionally strong and I think it demonstrated that last year.

We are investing in that equity by upgrading the packaging for Grizzly as we speak, and we believe it has a very loyal franchise. So I think we’ll continue to see growth on Grizzly, and certainly Grizzly gets caught in the fray as any brand of 25 shares will, when there’s extensive competitive activity.

Judy Hong - Goldman Sachs

Tom, just my final question, on your comment about pension in 2010, I mean, it seems like, just given the contributions that you’ve made, it’s hard to believe that you won’t see a positive impact in 2010 as a result of that. I’m just wondering if you can just elaborate if the change any other assumptions so you’re not seeing as much of a positive benefit there.

Tom Adams

Actually, we did see a positive benefit vis-a-vis our earlier projections on pension expense and pension expense in 2010 would have trended higher, but for the earnings that we had in the pension plan, which were roughly 25% this year. So we actually did see some positive benefits from the earnings and the contributions that we made, Judy.

We stating it right now, our pension plan is about 80% funded on an accounting basis versus about 66% funded last year. On a Pension Protection Act basis, which is a contribution basis, we’re at about 90% funded. So we’re actually feeling very good about the progress that we made against the pension plan expense and holding those expenses level and ultimately bringing them down overtime.

Judy Hong - Goldman Sachs

In 2010, you don’t envision those expenses coming down, so it’s just basically staying stable?

Tom Adams

Overtime, they will come down, Judy, assuming that the pension returns exceed our benchmark of 8.25%, but this year, flat.

Operator

Your next question comes from David Adelman - Morgan Stanley.

David Adelman - Morgan Stanley

Susan, at the meeting you hosted a couple of months ago; you outlined an expectation for Conwood to have high single digit operating profit growth in 2010. Is that still the internal expectation?

Susan Ivey

Yes, it is, David.

David Adelman - Morgan Stanley

What are you anticipating in terms of the decline in cigarette volumes for the industry during 2010? Implicit in that, what’s sort of your current outlook for the likely magnitude of state excise tax increases this year?

Susan Ivey

We are estimating the industry decline this year will be between 4% and 5%. We think that state excise taxes will be similar levels to ‘09.

David Adelman - Morgan Stanley

Within the cigarette categories Susan, if you look at the premium to discount mix, if you go back say four quarters ago and look at the several years prior to that point, there had been modest consistent growth in the premium mix for a number of years. Now that’s changed, at least for a period of time. Presumably both because of your success with Pall Mall and the economy, and I’m just curious if you stepped back from what’s happening today, do you think that the premium category has reached a tipping point in the United States?

Do you think the discount segment, even as the economy improves, will be flat to up from here? Tied into that with higher cigarette prices, do you think that relative pricing gaps are becoming less important in consumers’ choice, that you need a now or relative pricing gap today to get someone to smoke a premium brand than may have been the case in the past?

Susan Ivey

As you say, we did see some declines in the premium segment in 2009. Haven’t seen that in recent years, when the economy’s been booming, but it certainly can’t be surprising. I mean, we’ve had a very large premium segment here and with 25% price increases in a recession and growing unemployment, it’s not surprising that consumers desire honest value across all of their disposable income purchases.

It gets harder and harder to determine, what is a value brand? What is a premium brand? The segments are blurring. There is an awful lot of promotional activity in many of the premium brands and then of course there is the value brand segment, an everyday value like Pall Mall and then there’s the non-big three. So, I think that we have to see what happens as the economy improves, do consumers trade back up or do taxes and prices keep them searching for honest value.

I feel that our strategies in a good place, Pall Mall’s time is now and we will see that play out, but, I think the premium segment will always be very, very large, but I do believe consumers do have price points of which they won’t go beyond and as long as they’re under pressure economically, that we’re unlikely to see up trading in the near term.

Having said that, we look at Santa Fe this year who had double-digit volume growth in the super-premium segment because obviously the economy does not affect all people equally, but I think we have to watch this unfold for a while. We’ve not even lapped that tax increase.

David Adelman - Morgan Stanley

Then lastly, Tom, at year end, can you tell us what the dollar amount of the unfunded element of the pension and retirement programs were on an accounting basis?

Tom Adams

Let me get back to you on that. I mean, that’s in actually a draft of our 10-K and I have that in front of me, David, but it’s significantly less than it was last year.

David Adelman - Morgan Stanley

The statistic you gave on 80% was that before or after the January contribution?

Tom Adams

Before.

Operator

Your next question comes from Adam Spielman - Citigroup.

Adam Spielman - Citigroup

Can I ask two questions? You mentioned the growth of the non-big three in the course of the year. I was just wondering if you could sort of explain how that developed quarter-by-quarter. I guess I’m really trying to see whether there was a surge of that towards the end of the year, to try and think about what might happen in 2010?

Susan Ivey

I would say no, it grew six-tenths of the year and actually it slightly declined in the back half as there was more promotion obviously for instance, in Pall Mall and in other premium discount. So I would say ‘08 on ‘07, that segment grew about three-tenths and that was toward the back half, but as we look into ‘09, it grew six-tenths, but started a little bit of decline after we got through the first couple months of that tax increase so that’s how I would look at it going forward.

Adam Spielman - Citigroup

Thank you very much for that and then secondly, on the dispute of the MSA payments, when should we expect to hear something on that? Can you just sort of elaborate on what the process is?

Susan Ivey

I can elaborate a little bit on the process, but the arbitration process is set out in the agreement and we’ve now sort of reached the point where we picked the panel. We’re just about to finalize that. I would expect Adam, that we won’t see any result of that probably until into ‘11, but we’ll keep you posted. It’s too early to say because they then have to determine what discovery, what’s the process going to be for exchanging information and presenting it to the panel. So as that unfolds, we’ll keep you posted during the year.

Operator

Your next question comes from Marc Greenburg - Deutsche Bank.

Marc Greenberg - Deutsche Bank

Susan, assuming we get back to more normalized volume decline, following FET lapse, with regards to Camel, what kind of sign posts will you look for to feel as though the brand’s health there is strong and vulnerability to trade down has lessened somewhat and then with regards to the portfolio, now that the growth brands are more than half, are you in a position where you can start saying with some conviction that you don’t think cigarette market share losses are going to be an issue from here?

Susan Ivey

Thanks Marc. I think on the overall cigarette share at Reynolds, that really we have seen stability over the last now seven quarters or whatever it is, and I feel very good that those lines have crossed and that we have met our objectives in terms of trying to stabilize a bit that support sector and then continue to grow the growth brands. When we look at Camel & Camel’s performance last year, I mentioned a little bit of this in my remarks, but we de-listed in the last two years 14 SKUs on Camel and we did that for strategic reasons.

We wanted to make the offer clearer to the consumer. We wanted to de-list some of the marginal styles and focus on its core. We’ve also significantly pulled back on the number of line extensions and of course that can show a pipeline and that can show growth in shipments that may or may not be real overtime.

Camel, with Crush being its really most recent innovation, we’re focused on relevant differentiation. Seven-tenths of a share point in a style, we feel very good about. We feel good that Camel gained a tenth of a share point in the premium segment and we feel good we reduced the promotion levels on Camel last year actually.

So when you take that and add to it, three times of a share equivalent from Camel Snus, we feel that Camel is progressing very well and its demographic profile remains very strong. So we will obviously, continue to invest in Camel to continue to watch those markers looking at Camel as a total tobacco brand, but we are happy with Camel’s performance.

Marc Greenberg - Deutsche Bank

Just a follow-up on your comment on the double-digit profit growth for the smoker’s category, I guess close to it. For guidance for 2010, does that assume that the current promotional environment dissipates over the course of the year?

Susan Ivey

It’s very difficult to obviously, know what will happen in the competitive environment. Obviously, we’ll watch that very closely. Obviously, it depends on how much Grizzly has to get into the fray, but we feel, there was a lot of competition last year. There was a lot of price movement last year. We believe that Grizzly will continue really to go from strength to strength.

As I said, launching a new style called Grizzly 1900 in the first quarter of this year. We feel that has good potential and Grizzly is the number one brand in the space. So we are fairly confident that high single digit target is achievable.

Marc Greenberg - Deutsche Bank

Last question for you or Tom with regards to your cash balances and the dividend policy; just wondering what kind of a role in the future you might envision share repurchases playing, especially as earnings begin to grow again?

Tom Adams

We look at all kinds of ways to get money back, to get our cash back to the shareholders and primarily we’re doing it through dividends and increasing our earnings right now and the 75% payoff. Share repurchase is something that we discussed. No promises on that, but it’s something we discussed. What we do at least for the first half of this year have some demands on our cash with respect to the MSA payments, paying down the debt.

We’ve already made the pension plan contribution and then we have a fair amount of capital expenditures for those Conwood facilities that I referenced in my remarks. So once we get through the first half of the year, we’ll look a little bit harder at that.

Operator

Your next question comes from Ann Gurkin - Davenport.

Ann Gurkin - Davenport

Wanted to start with the moist-snuff overall category, you all indicated the industry was up 4.4%. I thought it was supposed to be up in the range 6% to 7%. So can you help me understand that?

Susan Ivey

Sure, 4.4% is the shipment growth we saw in the category last year. Our view is that, consumption grew more than that. We would put consumption in more in the 5.5% to 6% but certainly consumption was higher. They were a lot of changes in inventory in moist-snuff and they were changes in promotional vehicle.

Ann Gurkin - Davenport

The outlook for shipment growths, for 2010?

Susan Ivey

Really we’re looking at consumption growth, but I would say, again we would look again 5% to 6%.

Ann Gurkin - Davenport

For both consumption, and shipment?

Susan Ivey

Sure.

Ann Gurkin - Davenport

Susan I don’t know if you care to comment at all on the menthol cigarette category? Any update on in relation to FDA comments, any update on the buy value of that category? Anything you want to share?

Susan Ivey

I don’t have any update and I think, we’ll see how the agencies tackles this and we’ll keep you updated with. The agency is still really sort of gathering its membership, so we’ll see our experience today we’ve been working very closely with the FDA on the submission processes etc. Some of those things have been delayed as they get setup. So we’ll see if we get a different timetable for that report or how it will progress, but I don’t have any new news.

Operator

Your next question comes from Thilo Wrede - Credit Suisse.

Thilo Wrede - Credit Suisse

A quick question on the RAI key performance, when you compare that with the second quarter performance the volume and pricing growth was fairly comparable between both period, but in the fourth quarter adjusted EBITDA was down a 11% well it was up 6% in the second quarter, what was the difference between the two quarters that the EBIT development and what’s the different?

Susan Ivey

I mean I think we’re going to find difficulties even as we do in ‘09 and we will in ‘10, trying to go back to these quarters. If you remember there was a huge de-load in the first quarter and a massive reload in the second quarter and so the second quarter really is the operation because if there was a lot of full revenue margin built in that was not really an equivalent ongoing consumption path.

So I think as we go through the year, remember the first quarter of last year nobody shipped anything for the second half of March and then everybody shipped a lot in April. I think it’s going to be very difficult until we get into like the third quarter ‘10 to really make any real comparison year-over-year.

Thilo Wrede - Credit Suisse

So does that mean in the coming quarters to this pulse promotions for Pall Mall. The EBIT growth will be more similar to what we saw in this quarter rather than what we had in a second quarter?

Susan Ivey

I think you can’t make that comparison, as I implied before the current promotional rates on Pall Mall are also not similar to the promotional rates that we used in the second quarter, when we were spending into the tax when we saw a lot of consumers in motion looking for value. So it’s not the same promotional levels and it’s not going to be the same shipment pattern. So I think you just need to watch that we’ve sort of given the guidance for ‘10 and that is all planned in.

Thilo Wrede - Credit Suisse

Then the Native American Spirit growth that you pointed out, Susan, how much of that was driven by growth of roll-your-own product, because I think it is amazing that Native American Spirit grow in this down trading environment?

Susan Ivey

It shows, as I said it doesn’t affect everyone equally. We made some investment in trade marketing in 2009 at Santa Fe and increased distribution really kind of meeting late in demand and so they did actually with their market share ever and I think they’re roll-your-own, I don’t know it’s a little bit. It held up very well.

Despite that enormous tax increase because the consumers of Natural American Spirit, who do roll, they roll because they love rolling. They don’t roll because there was a price advantage or tax advantage, so versus other roll-your-own like value segment roll-your-own it held up very well and cigarette share grew significantly.

Thilo Wrede - Credit Suisse

Then last question I had you, the market shares for Snus and Camel Crush, don’t seem to have really move throughout the year. Have those two products plateau already or have they maxed out already their share potential?

Susan Ivey

I would say no. I mean to hold up at seven tenths, when the premium segment lost 1.6. I think on Camel Crush was the strong performance. So I think we believe that there’s still growth opportunity in Camel Crush and as I mentioned we’ve now launched that innovative capsule technology on two of Camel’s core menthol styles with new packaging shipping this month and we expect that those will also provide additional growth in that category.

Operator

Your final question comes from Adam Spielman - Citi.

Adam Spielman - Citi

Can I comeback, so it’s a realistic question that actually David asked. I’m not sure you answered clearly. Do you think the era of worrying about relative price points as opposed to absolute price points in the United States? I guess, whether you think that the U.S. market has become much like the market, you see in Northwest Europe, where we don’t really talk about price points at all?

Susan Ivey

I think I answered it in best I could. We have not even laughed the tax increase, we have not even gone 12 months, we still have very high unemployment in this country and I think it’s premature to say that we won’t be looking at relative price gap. I do believe the absolute pricing and absolute pricing by state is very material, because that’s the actual outlay, but I think we need to have a little more time under our belt with these very significant increases to watch consumer behavior and brand promotional spending and the results.

Operator

We have no further questions in the queue. I would now like to turn it back over to Morris Moore for any additional comments.

Morris Moore

Thank you for joining our call again this morning.

Operator

That does conclude today’s conference. Thank you for your participation.

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Source: Reynolds American Inc. Q4 2009 Earnings Call Transcript
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