Reynolds American's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.11.14 | About: Reynolds American, (RAI)

Reynolds American, Inc. (NYSE:RAI)

Q4 2013 Results Earnings Conference Call

February 11, 2014 09:00 AM ET

Executives

Morris Moore - Vice President, Investor Relations

Dan Delen - President and CEO

Tom Adams - Chief Financial Officer

Analysts

Vivien Azer - Citi

David Adelman - Morgan Stanley

Michael Lavery - CLSA

Bonnie Herzog - Wells Fargo

Judy Hong - Goldman Sachs

Thilo Wrede - Jefferies

Operator

Good day, ladies and gentlemen, and thank you for standing by. And welcome to the Reynolds American Incorporated Fourth Quarter 2013 Earnings Conference Call. At this time, all participants are in a listen only mode. Later we will conduct a question and answer session and instruction will follow at that time. (Operator Instructions). As a reminder, today’s call maybe recorded.

It’s now my pleasure to turn the floor over to Morris Moore, Vice President, Investor Relations. Sir, the floor is yours.

Morris Moore

Good morning, and thank you for joining our call. Today, we'll review Reynolds American's results for the fourth quarter and full year, as well as our guidance for 2014. Our discussion will focus on adjusted results, as management believes this provides better perspective on 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 are not required to publicly update or revise any forward-looking statements.

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

Dan Delen

Thank you, Morris. And Good morning, everyone. Before I give you my perspective on RAI’s fourth quarter and full year results. I thought it might be appropriate to open our first call of the call year with two important updates for our shareholders. The first is today’s announcement of a 6.3% increase in our quarterly cash dividends.

As many of you know RAI had consistently demonstrated its commencement to returning value to shareholders as then dividend increase, speaks to our confident and the ability of our operating companies to make further progress in enhancing shareholder value in the year ahead.

In the next update, I would like to share with you is some color on the successful performance of VUSE digital vapor cigarette, the first and only e-cigarette that’s designed and assembled in the U.S. VUSE continues to deliver outstanding results in Colorado, its firstly to market and remains the market leader in that stage.

Its important to know that in Colorado VUSE has driven substantial growth not only in its own share of market but also in the e-cigarette category as a whole. Since VUSE’s introduction into the state in July the e-cigarette category in Colorado has tripled in size driven by strong adult smoker interest in VUSE. In the last month, the brand has been rolled out to the neighboring state of Utah. And I am pleased to report that this expansion is also going very well. Adult smokers appreciate VUSE as distinctive and superior features.

As many of you have heard me say before trial of e-cigarette has been high amongst adult smokers in the last couple of years. But repeat purchases were considerably lower. To us that was a clear indication that the products on the market before VUSE simply weren’t meeting smokers’ expectations.

That’s why we are pleased by the fact that cartridges for VUSE are by far the brand’s largest selling SKU. In fact cartridges are making up about 80% of the brands total sales volumes. This demonstrates clearly that consumer is not just trying but adopting VUSE and this increases our confidence in brand’s potential among adult smokers who are switching to smoke free alternatives.

R.J. Reynolds Vapor continues to increase production capacity and the company is planning a significant geographic expansion of VUSE by the middle of this year. However the rate of expansion will depend on VUSE’s off take and the growth of the e-cigarette category. As you would expect, this expansion will require a significant investment which is reflected in our earnings guidance for 2014.

As I am sure you saw on our press release for the full year, RAI expects EPS growth in the range of 3.5% to just over 8%. I would [note that] there are guidance not only factors in investments behind VUSE but also includes additional investments in the equity building initiatives for our company’s key cigarette and moist-snuff brands. All-in-all some positive news to start off the year, as well as the solid growth projections for the year ahead.

But before I get too far ahead of myself, let’s take a look back at last year and especially our fourth quarter results.

Overall 2013 was a great year for us. R.J. Reynolds, American Snuff and Santa Fe all demonstrated solid underlying business performance while continuing to position themselves for sustainable long-term growth in a changing and challenging industry. These companies make significant equity building investments in their key brands. And we have seen these efforts to really payoff over the past year.

During the fourth quarter, I am pleased to report that RAI continues to improve its profitability with additional strong market share gains on our operating company’s key brands. And R.J. Reynolds, growth was solid in both adjusted operating income and margins.

The company benefited from higher cigarette pricing and lower MSA costs and its growth brands Camel and Pall Mall continue to demonstrate a strong momentum. But the quarter was not without the challenge. As we stated in our earnings release, the fourth quarter was marked by lower than expected cigarette wholesale inventory levels, which negatively impacted cigarette volumes.

For the industry cigarette volume was down 6.2% in the fourth quarter and down 4.6% for the full year. It’s fair to say that this was a pretty tough comparison as industry volume declines were below trend in the prior year. In 2012, industry volumes were down 2.3% for the year while the fourth quarter was down just 0.8%.

For some additional perspectives, when we look at industry volume declines over the past several years, there has been about 3.5%. At R.J. Reynolds fourth quarter cigarette shipments were down 8.6% from the prior year quarter. After adjusting for wholesale inventory changes, the company estimate says volume was down about 7% in the quarter and down about 6.2% for the year, this compares with an adjusted industry decline of about 4.2% for the year.

Industry wholesale inventories were approximately 7.2 billion units at the end of the fourth quarter down about 1.4 billion from the prior year quarter while R.J. Reynolds’ inventories of approximately 1.8 billion were down about 400 million. There is no doubt that the continued slow economic recovery as well as the increasing migration of smokers to smoke free products are also impacting cigarette volumes. But as we start this year, volumes are returning to more normalized run rates.

Turning to cigarette market share. R.J. Reynolds’ total cigarette market share was down three-tenth of a percentage points in the fourth quarter at just over 26%. And I think it’s important to note that the company’s total share has remained stable across the year.

R.J. Reynolds’ two growth brands Camel and Pall Mall continue to help offset declines on the company’s other brands. I am very pleased to report the Camel and Pall Mall found new opportunities for growth in the fourth quarter benefiting from targeted and efficient promotions strategies and effective equity building initiatives.

Their combined market share rose 0.6% to just over 18%. And these two brands account for about 70% of R.J. Reynolds’ total market share. Camel’s fourth quarter shares increased by 0.4% to 9% and that’s the brand’s highest share of market since 1967. And most premium menthol styles again contributed to the brand’s growth adding 0.3 of a percentage point for a 3.6% share of market.

Camel is benefiting from the equity investments that the company made on the brand last year. The brand’s Taste It All Campaign is uniting the Camel portfolio of innovative products with one voice and extends an invitation to adult tobacco consumers to explore the choices offered by the brand. This is helping to drive interest in Camel SNUS, Camel’s market leading smoke free offering.

Camel SNUS, which is benefiting from the recent national expansion of Frost Large style, continues to perform well in the growing SNUS category. The brand continues to hold about 80% of the SNUS market.

Pall Mall also continues to make steady gains driven by powerful true value proposition. Pall Mall increased market share by 0.2 percentage points in the fourth quarter to 9.1%. Value conscious consumers really like the fact that Pall Mall is a longer lasting cigarette at an affordable price. And about of those who try it tend to stick with the brand.

R.J. Reynolds continues to drive trial of Pall Mall with the efficient and selective use of discounting and promotion. And the company has plans to make additional enhancements to the brand this year.

Now, turning to American Snuff, I am really pleased with their achievement during the quarter and for the year. The competitive environment in the moist-snuff category has continued to intensify, but even in light of this environment American Snuff just continues to deliver outstanding results. The company reported substantial increases in adjusted operating income and margins driven by flagship Grizzly brand, which turned in another excellent performance. American Snuff earnings growth reflected higher pricing and volume, as well as the efficient execution of their business strategies.

The company's moist-snuff volume increased by more than 8% in the fourth quarter, again outpacing industry growth of about 5% that help the company improve its moist-snuff market share by 0.7 of a percentage point from the prior year quarter to 33.3%.

Grizzly, the number one moist-snuff brand grew its market share by a 4 percentage points in the fourth quarter to 30.3% and that was on volume growth of 90.6%. Innovation also plays a role in Grizzly's strong momentum. The brand is just expanded nationally its bolder flavor, wide-cut wintergreen style. Grizzly wide-cut wintergreen gains independent recognition by winning CSP's 2013 retailer choice for best new product in OTP category.

I have no doubt hat Grizzly wide-cut wintergreen will continue to broaden the brand’s appeal. In addition to the brand’s outstanding performance in wintergreen, Grizzly continues to do especially well in the pouch consumer segment, delivering category leading growth with this rapidly growing moist-snuff style.

Now turning to Santa Fe, the company finished up the strong year with the double-digit increase in adjusted operating income and I might add that includes a significant investment in their brand equity building initiatives. Santa Fe's Natural American Spirit super premium brand added another 0.2 of a percentage point to its market share to finish the year at 1.5%. Natural American Spirit grew volume by nearly 10% in the quarter and that was against the strong year ago comparison when the brand grew over 20%.

National American Spirit’s distinctive out of the frame natural tobacco styles including (inaudible) with organic tobacco are benefiting from the company’s equity building initiatives and there is still plenty of room for growth for this top 10 brand.

So, to wrap it up, RAI and its operating companies made substantial progress last year despite the difficult environment and we have exciting plans for continued growth ahead.

Now, I’ll turn the call over to Tom. Tom?

Tom Adams

Thank you, Dan and good morning everyone. Before I cover our financial performance in detail, I want to highlight the dividend increase that we announced this morning. This is RAI’s 11th dividend increase and our 39th consecutive quarterly cash dividend since the company was formed almost 10 years ago, a great milestone in itself and illustrates our deep commitments to returning value to our shareholders.

Over the years we’ve demonstrated an ability to build the financially strong group of companies in advanced changing environment and we remain focused on finding new opportunities for profitable growth and enhancing shareholder value over the long-term. Today’s increase of 6.3% takes the quarterly dividend from $0.63 a share to $0.67 for an annualized rate of $2.68.

Now I will turn to our latest results. RAI’s fourth quarter adjusted EPS of $0.77 was up 1.3% from the prior year quarter, with higher pricing, lower MSA cost and the impact of our share repurchase program more than offsetting lower cigarette volumes. Adjusted results exclude $0.15 for the early extinguishment of debt, $0.04 for non-cash trade market impairments, $0.03 for other tobacco-related litigation and $0.01 for implementation cost. On a reporting basis, fourth quarter EPS was $0.54.

For the full year, RAI’s adjusted EPS was $3.19, up 7.4% from the prior year period. These adjusted results exclude the items I just mentioned, as well as the one-time benefit from the NPM partial settlement and charges for Engle progeny losses. On the reported basis, full year EPS was $3.14. Even with the negative impact of lower cigarette volumes, RAI continued to improve adjusted operating margin, which increased by 0.8 of a percentage point in the quarter to 35.4%. For the full year, adjusted operating margin rose 2.1 percentage points to 36.6%.

Now I will turn to our operating companies’ performance, we’re all focused on adjusted results. Please refer to the schedules at the end of our earnings release, the reconciliations from our GAAP to adjusted results.

R. J. Reynolds continued to balance profitability and market share in the fourth quarter, increasing adjusted operating income by 4.1% to $595 million. And for the full year, the company delivered adjusted operating income growth of 7.6% to $2.5 billion. The company’s fourth quarter adjusted operating margin also strengthened, increasing 3 percentage points to just over 36%. That brought the year margin to 36.6%, up 3.6 percentage points.

As Dan mentioned, American snuff benefited from higher moist-snuff volume and pricing in the fourth quarter, increasing adjusted operating income by 17% from the prior year quarter to $116 million that brought the full year’s adjusted operating income to $424 million, up by just over 12%. American Snuff’s adjusted operating margin also came in strong at 58.9% for the quarter, up 2.5 percentage points, bringing the full year adjusted margin to 57.1%.

Now turning to Santa Fe where we have come to expect a consistently strong performance. For the fourth quarter, the company increased adjusted operating income by 12.3% to $73 million driven by higher volume and pricing. And for the full year, Santa Fe’s adjusted operating income increased by nearly 18% to $280 million.

And I would note that the company delivered this growth, while making significant investments in brand equity building. Santa Fe’s fourth quarter adjusted operating margin was a very strong 49.1%, bringing the full year margin to just under 49%.

I’m pleased to say we also made substantial progress on our debt structure last year. I’ll remind everyone that RAI completed $1.1 billion public offering of senior debt securities, while completing the make-whole call of $975 million of debt that was scheduled to mature in 2015 and 2016.

RAI also repaid its $500 million term loan, while R.J. Reynolds Holdings repaid its remaining $60 million in maturing debt. During the fourth quarter we repurchased 3 million of shares under the company’s $2.5 billion share repurchase program for $150 million, bringing our total repurchases under program to 47.6 million shares for $2.1 billion.

RAI ended the year with $1.5 billion in cash balances while expansion plans continued to be well funded at about 93% on a PBO basis. With respect to the arbitration panel ruling this past September on the remaining 2003 NPM adjustment disputed payments, I would remind you that R.J. Reynolds believes that it’s entitled to approximately $266 million plus interest in earnings. While the company expects to receive these funds, given the uncertainty of the timing and the process no amounts have been recognized in the fourth quarter. Consequently these amounts will be recorded as appropriate when these uncertainties are resolved.

Finally, I would like to congratulate our operating companies on their achievements in 2013. They are demonstrating strong momentum on many fronts and that allows us to issue 2014 EPS guidance in the range of $3.30 to $3.45. As we have made it clear, this guidance takes into account significant investments in the national expansion of VUSE e-cigarette especially in the first half of the year.

This expansion is part of our strategy to deliver long-term sustainable growth. Thank you. Now, I will turn to the Q&A portion of the call. Operator, would you remind our callers how to get into the queue.

Question-and-Answer Session

Operator

Sure. Thanks sir. (Operator Instructions). And it looks like our first phone question will come from the Vivien Azer with Citi. Please go ahead, your line is now open.

Vivien Azer - Citi

Hi, good morning.

Dan Delen

Good morning Vivien.

Vivien Azer - Citi

My first question has to do with your outlook for the U.S. cigarette industry in terms of volumes; you mentioned slight improvement in January. But kind of given the trajectory of the category, can you offer a little color on where do you think 2014 might fallout relative to 2013 please?

Dan Delen

Sure. I think I mentioned in my comments that what we're seeing is the multiyear kind of historical trend is being down about 3.5% from a cigarette category point of view. And we would estimate that 2014 is going to come in right around or close to that number as well, so down 3.5%.

Vivien Azer - Citi

And what is that factoring in terms of your expectation for volume shift to non-combustible products, either e-cigarettes or NXT?

Dan Delen

Well, I think I may be the way I would describe it is really the largest impact on that number still is the price sensitivity of demand in the marketplace, there is the macroeconomic kind of backdrop to that as well, and then there is secular decline in the category. But of course, we've also factored into that sort of consistent rates of growth of consumers migrating to some of the other categories, particularly smokeless and more recently e-cigarettes.

Vivien Azer - Citi

Fair enough. And then turning to e-cigarette, I recognize that it’s very early days in Utah, but Dan you did mention some of the struggle with e-cigarette category. So, I’m curious, even early days in Utah, are you seeing a re-acceleration in the e-cigarette category growth like you did in Colorado or is it too early to say?

Dan Delen

I think that's really a little bit too early to say. I think I mentioned in my comments that we’ve seen the category actually tripe in Colorado. And I’m very happy to report as well that we become market leader there and that a significant proportion, about 80% of our sales are actually coming through cartridges, which means there is a lot of repeat purchase going on out there. And I would say thus far there is no reason to indicate that Utah won’t be a similar experience but I do think it’s a little bit early to actually make that call.

Vivien Azer - Citi

Fair enough. And then my last question has to do with your optimal mix or view as you mentioned the 80% mix towards cartomizers to cartridges, is that kind of the target mix on a longer-term basis, is that the kind of mix you need to drive profitability in the business longer-term when you get scale?

Dan Delen

Yes. I think we’re very confident in the long-term profitability, obviously of this category and our product within it. But what I would say is from an economic point of view, the more cartridges you sale, the better long-term margins will be.

Vivien Azer - Citi

Fair enough. Thank you very much.

Dan Delen

All right, thanks Vivien.

Operator

Thank you, ma'am. Our next phone question will come from David Adelman with Morgan Stanley. Please go ahead. Your line is now open.

David Adelman - Morgan Stanley

Good morning everyone.

Dan Delen

Good morning David.

Thom Adams

Good morning.

David Adelman - Morgan Stanley

Dan, on e- cigarettes, what run rate of expenses should investors expect in the first half of the year versus the expense rate during the fourth quarter, is it going to further step up?

Dan Delen

The short answer to your question is yes it will further step up. But let me give you a little bit of perspective on that, because what you’re seeing is expense is not all related to Colorado and now Utah, what you also have a significant expense in there in preparation for our plans and more aggressive plans going forward. And I’ve indicated in my comments that we are expecting a significant expansion and distribution in the first half of the year, so there will be expansions associated with that as well.

David Adelman - Morgan Stanley

And as you go national Dan, do you think you will be able to provide the same level of -- sort of execution detail resources that you are providing in these two states on a national basis; is that the opening tender, or is that unrealistic as it becomes a broader effort?

Dan Delen

No, I think it is very realistic. I think really a lot of our marketing efforts in Colorado, we have actually had to tap those back in that state, largely due to the fact that we’ve been product constrained out there and we had allocations out there at wholesale and retail really all the way through the fourth quarter. So, a lot of our marketing efforts that we’d originally designed weren’t fully deployed. So really from a resource point of view but also from a time and attention point of view, from a field force point of view, I am very confident that we can replicate that experience as we expand distribution.

David Adelman - Morgan Stanley

And the tripling of the e-cigarette category Dan in Colorado, that brings it to a cigarette equivalent volume basis of about what from a market share perspective?

Dan Delen

Yeah, David, I point you back to what we actually talked about at our investor day. I believe at that stage, we had a number that was slightly north of about two share equivalent.

David Adelman - Morgan Stanley

Okay. And then lastly, maybe for Tom, what assumptions on share repurchases is embedded in the guidance, is it the completion of the current $2.5 billion program more or less around mid-year but nothing in the back half? And if that is the assumption, is there -- even it’s not in the numbers, is it the intent to continue with buybacks beyond the current program?

Tom Adams

The assumption that’s built in the plan David is to basically complete this by the end of the second quarter. And we haven’t built anything into the forecast beyond that for share repurchases, we are -- that's a Board decision and we are in conversations with the Board about that.

David Adelman - Morgan Stanley

And you would want to do it under the same terms with the BAT pro rata participation?

Tom Adams

That's part of the conversation.

David Adelman - Morgan Stanley

Okay. Thank you.

Tom Adams

Thanks David.

Operator

Thank you, sir. Our next phone question will come from Michael Lavery with CLSA. Please go ahead. Your line is open.

Michael Lavery - CLSA

Thank you. Just to clarify, in Colorado, you said that the 80% of sales was from refills; is that sales or volume, because that would a lower price point in the startup [care point?]

Dan Delen

Correct, I’m really quoting a volume number there. So, 80% of individual cartridges use was volume.

Michael Lavery - CLSA

Okay. And then you said category tripled, how much of that is -- was there some acceleration in competitors’ sales as well or is all of that going to your own brand?

Dan Delen

Well given our market share in the state, I think it’s a fair conclusion that all of that was actually accounted for by VUSE.

Michael Lavery - CLSA

Okay, that's great. And then in terms of pricing on e-cigarettes, typically even though it’s a little bit of apples and oranges with the refills versus packaged cigarettes in terms of how the cost compare, the consumer typically could reasonably expect to spend less on e-cigarettes if they switch from cigarettes. Do you think you could ever get that pricing a parity with cigarettes and if so, how?

Dan Delen

Well, I think that really depends on the competitive dynamic in the category long-term, so you are asking me to speculate on future pricing. Now, I think it’s a little bit premature to do that. I think we’re happy and see our way though a smaller than sustainable operating margin and process to this category going forward. I think there are significant opportunities to generate increased value in this category and for probably as long-term, but at this stage [it’s hard] to comment on future pricing strategies.

Michael Lavery - CLSA

Okay, that’s fine. In the quarter the margins without the benefit from the MSA savings look like they were down maybe are in the 100 basis points or more. Can you just give a little color on what the drivers were for that and specifically I am looking at RJR segment?

Dan Delen

Yes. I think Michael maybe rather than to get into the specific numbers at the moment what I would really point you back to is the guidance, all the way back to this time last year when we issued the guidance, it really was about the investments that we made in the equity of some of our key assets at the different operating companies. Specifically the brands we called out at that stage we were going to make significant and have made significant additional equity investments was behind the Camel brand at R.J. Reynolds, significant additional investments behind Natural American Spirit at the Santa Fe natural tobacco company as well as Grizzly from the American Snuff Company. And I think you have seen that the performance of each of those brands doing quite well and a lot of that growth is coming not from a pricing point of view but really from a continued enhancement to the brand equity.

And maybe in other way just as a perspective to think about brand equity. Brand equity overtime actually reduced this, the price sensitivity of demand out there in the market place so that you can continue to generate growth without actually having to put additional pricing dollars into the marketplace. And that of course is part of a long-term strategy, which we brief as a very significant but also a very worthwhile investment in our business.

Michael Lavery - CLSA

That's helpful. I guess just one clarification on that. Your first half it looks like excluding MSA savings would have been roughly flat margins in that segment. And the second half comps were a little easier. Was it, is it just pacing of that spending and that it was second half and even more so 4Q skewed?

Dan Delen

Yes. I wouldn't say so much for Q4, but I do think there was a little bit of timing as we sort of went through the year or begin to deploy these dollars. So, I think it's more second half to first half. I think the most significant impact in Q4 actually has to do with some of the wholesale inventory dynamics.

Michael Lavery - CLSA

Okay, thanks. And then just last one on the $266 million of savings that's not quite finalized. How is that reflected in guidance for next year? Is that included or would that be offset during numbers once the timing is known?

Tom Adams

Hi Michael, this is Tom. It's not included in our guidance. So it would upside depending upon the manner in which it comes through it.

Michael Lavery - CLSA

Okay. Thank you very much.

Tom Adams

Welcome.

Dan Delen

Thanks Michael.

Operator

Thank you sir. Our next phone question will come from Bonnie Herzog with Wells Fargo. Please go ahead, your questions please.

Bonnie Herzog - Wells Fargo

Good morning.

Dan Delen

Hi Bonnie.

Tom Adams

Good morning.

Bonnie Herzog - Wells Fargo

My first question is on VUSE, you mentioned that it's roll out will depend on the growth of the e-cig category. And there have been some questions surrounding what appears to the slight slowdown of the category and I am hoping you could talk to us about what do you think might be driving this. And then also I'd love to hear your thoughts on the growth of the tank or open ended systems that appear to be an emerging trend?

Dan Delen

Yes. So, let me give you a couple of perspectives. I think we’ve historically talked to you about some of the dynamics in that category and that dynamics that we’ve talked about was a significant level of trial out in the marketplace so very high levels of trials but relatively low levels of repeat purchase or actual adoption and consistent adoption of some of these products. And that’s really the dynamic in which we design VUSE and its delivering on that. So, I think we are as confident as ever in our product and its ability to actually compete but not just to generate trial out there, to generate regular conversions. So we’re not seeing that dynamic as we sit here today.

Yes. I’ve read a lot and about what’s happening potentially with some of the other products but I would point you back to those comments about the level of adoption of on trial being the major barrier for the long-term sustainability of the category in general. And then as we look at some of those open ended systems, yes there are levels of growth out there, of course we see that and we’ve picked that up. And I think it’s going to be very, very interesting and key to kind of watch what happens from a regulatory point of view out there. In terms of what happens with these open ended systems just because people can put any types of products in terms of liquid into them.

And I will just remind all our listeners on the call that VUSE actually is a closed system. These cartridges are actually sealed and physically the product even if somebody were to tamper and try to put extra liquid in there and so forth they physically shutdown. So we actually have a lot of those consumer protections actually built into our product.

Bonnie Herzog - Wells Fargo

Okay. That’s helpful. And then just another quick question on VUSE, in terms of the merchandizing, what did you learn in Colorado as it relates to the merchandizing of VUSE that helped you drive such impressive growth and then market leadership? And I am curious; do you think you are going to be able to replicate this nationally?

Dan Delen

Yes. I think one of the key benefits that we have as a company and key advantages we have, we have a very credible and I would argue an industry leading trade marketing effort out there. If you take a look, we’ve actually implemented significant restrictions on ourselves as we took VUSE to market.

We do not allow self service; this product is available from a self service point of view. So there have to be quick assisted sales. We have placed the product on the back bar and this is all to make sure that there are age verified sales. So we have from those restrictions and implement those to a significantly higher degree than our competitors and that’s just working on the long-term sustainability of the category.

And so, when we look at that, we are confident that we can deploy the merchandizing backlog effort in a very similar way in the geographies outside of Colorado.

Bonnie Herzog - Wells Fargo

Okay, thanks Dan. And then I had another question on Camel and Pall Mall. Could you give us more color around some of the key drivers behind the momentum for these brands? How much of your share gains are being driven by higher promotional spending behind the brands? Then also how would you characterize the competitive environment particularly with regards to down trading in light of Pall Mall’s volume growth and share gains?

Dan Delen

Okay. I think -- let me start; just give you a bit of perspective on Camel. I mean Camel is really going from string-to-string. I think the brand is doing very well out there. I think the most of noteworthy thing on the brand actually are the capital SKUs that are out there, they are up to 3.6 share points out there today. And I would really say the growth is driven, it’s really an equity driven growth based on very positive consumer demographics out there in combination with that equity. And that's what's really driving the growth there in addition to those innovative SKUs. So, very, very pleased with the performance year-on-year and quarter-on-quarter for that brand.

In terms of Pall Mall, maybe it’s worth here in longer terms from historic perspective, it grew very significantly some years ago. And I would say that its growth kind of slowed down in 2011, 2012 given the high degree of intensity from some of the pricing activity in the marketplace.

And more recently we’ve kind of come into a period of more equilibrium in the marketplace. And to what you see kind of popping back through is that that 50% retention upon trial, this is something we've talked about consistently overtime and this has been true throughout this period is upon trial from about 50% of consumers choosing to use Pall Mall regularly.

And so, I just think that there is slightly increased opportunity for trial of this differentiated, but value price proposition in the marketplace and that’s leading to these moderate levels of growth on Pall Mall.

I think from a marketplace point of view in general, getting to the second part of the question, we’re still seeing a little bit of down trading and aggregate in the category, but it certainly is at lower levels than we've seen some years ago. So, I would really say that that’s a moderating trend in the marketplace.

Bonnie Herzog - Wells Fargo

Okay, very helpful. Thank you.

Dan Delen

Thanks Bonnie.

Operator

Thank you, ma'am. Next phone question will come from Judy Hong with Goldman Sachs. Please go ahead, your questions please.

Judy Hong - Goldman Sachs

Thank you. Good morning.

Dan Delen

Good morning Judy.

Judy Hong - Goldman Sachs

So, I just had a few follow-up questions, first just is on the e-cigarette side. Dan, if your observation about the level of adoption being pretty high now with the repeat purchases and we already know that the trial of e-cigs have been pretty high for the category generally. I am just curious why we are not seeing even a meaningful, more meaningful pick up in terms of the category as a total percent of the total category even in places like Colorado?

And then secondly, as you think about the category, the cigarette category decline of 3.5% in 2014, it seems like that’s a bit of a, more of moderation in terms of the decline we have seen in 2014. So, as the category continues to grow in terms of the e-cigs and you’re expanding into national distribution, why aren’t we seeing more of an impact on the conventional cigarette category?

Dan Delen

Yes. Let me get to the first part of the question first, Judy. If we kind of look at it what I would say is that we as a brand have been able to generate those high levels of repeat, I don’t think that’s a general category characteristic. And it really talks to the differentiated product that we’ve actually designed and brought to market. So, I think we kind of need to separate that out from a thinking point of view.

And what we have seen is the acceleration of the category dynamics in Colorado specifically and we believe that that is accounted for by the superior performance of VUSE in that marketplace.

I think the other thing you need to kind of think about is some of the year-over-year kind of dynamics, if you're asking about the impact that might have on the cigarette category in total. And I would just take you back to 2012 when we saw the category actually declining less than its historical trend. 2013 slightly higher than historical trend because of those year-on-year competitors were a little bit difficult. So, as we come into ‘14, you need to think that some of those category dynamics are relatively easy from a compare point of view.

And of course, we'll need to see what impact the e-cigarette category has overtime on that and particularly VUSE. So, I'm not sitting here saying that I know exactly the e-cigarette category is going to be to the nearest 0.10 of a percentage point in 2014 and maybe off and depending on what happens with e-cigarette category and some of these numbers may shift overtime.

Judy Hong - Goldman Sachs

Okay. That's helpful. And then on the e-cig category, we've seen your competitors make some acquisitions both in the U.S. and outside the U.S. on e-cig category. How are you thinking about Reynolds strategy in the context of looking at potential acquisitions on e-cig? And do you think VUSE is enough to really take it to the next level both in the U.S. and potentially expand outside the U.S.?

Dan Delen

Well Judy, I think you know that really I can't speculate in terms of some of the M&A efforts going forward. But I would just tell you that we're very confident in the differentiated product design and the product and the brand, the entire sort of product proposition that we’ve put together for VUSE and very confident in its ability to compete well in the marketplace. And I think certainly we’ve proven that in Colorado. And I am confident that we’ll prove that again in Utah and so confident that we’ve already sort of telegraphed to yourself and others that we’re going to be have a significant increase again in distribution in the first half of this year.

Judy Hong - Goldman Sachs

Okay. And then just my last question, just in terms of the investment, so just want to clarify I understand sort of the nature of investments and the magnitude of the investment that you’ve made in 2013 across your core brands as well as VUSE and then as we look out 2014, how that mix of spending shifts and if there is also any changes in terms of the nature of spending behind your core brands? I think you’ve talked about potentially again increasing the equity related investments against your core brand there as well?

Dan Delen

Yes. I think it’s very hard for us to begin to parse out some of these investments on a brand-by-brand basis, Judy. But you’re right in your assumption that we’re looking or what we’re planning to do is to again increase some of the equity investments behind some of those key assets that we have during 2014. And of course we have VUSE in terms of expanding some of the distribution there. And those numbers are embedded in the guidance that we’ve actually issued for 2014.

Judy Hong - Goldman Sachs

Do you think it’s fair to say that the equity building initiatives behind Camel and Pall Mall have already been reflected in the positive share momentum or are those types of initiatives really take a little bit longer to kind of show up in the market share performance?

Dan Delen

Well, I’d react maybe slightly differently to each brand. If you remember we had a significant increase investment and Camel was on the list and received those additional investments during 2013. Pall Mall was not on that list. And what you really see happening with Pall Mall is more this 50% conversion upon trial sort of rate coming through, more opportunities for trial out there in the marketplace. So, I would really bucket those two brands differently in that kind of a scenario.

Judy Hong - Goldman Sachs

Understood. Okay, thank you so much.

Dan Delen

Thanks Judy.

Operator

Thank you, ma’am. (Operator Instructions). Our next question will come from the line of Thilo Wrede with Jefferies. Please go ahead. Your line is now open.

Thilo Wrede - Jefferies

Good morning, everybody.

Dan Delen

Good morning.

Thilo Wrede - Jefferies

Tom, your guidance for fiscal ’14, what assumption is included in the guidance for the impact of the end of the [grower] buyout?

Tom Adams

First of all, I can’t say that kind of like pricing Thilo and we actually don’t forecast or telegraph where pricing is. I think we are just going to have to wait and see how it’s come through. As you know, it ends at the end of the third quarter. And so we will see what the marketplace and where base going at that time.

Thilo Wrede - Jefferies

Okay. And then just a broader question, of your three main business segments between R.J. RT and American Snuff and Santa Fe, where do you still see the most margin upsides and where would that margin upside come from?

Dan Delen

We are looking for margin improvement at each of those three operating companies Thilo. And clearly we have seen growth at Santa Fe and with 49% margin and even more so at American Snuff. So, I think there is probably lots of opportunity at each of those companies and that's what we are focused on and basically growing those margins and delivering that to the bottom-line for shareholder -- increasing our shareholder value.

Thilo Wrede - Jefferies

So, in other words, just because the American Snuff is already close to 57%, it doesn’t mean that there isn’t any more upside at this level?

Dan Delen

I don’t think so, I think there is still upside. Now, keep in mind that these equity building initiatives at American Snuff are also attending to tamp that back a little bit.

Thilo Wrede - Jefferies

Okay. All right thank you.

Dan Delen

Thanks Thilo.

Operator

Thank you. (Operator Instructions). All right, because at this time I’m showing no additional phone questions in the queue, I’d like to turn the program back over to Mr. Moore for any additional or closing remarks.

Morris Moore

Thank you again for joining us this morning. If you have any additional questions, please contact us at investor relations.

Operator

Thank you gentlemen, and thank you ladies and gentlemen. This does conclude today’s call. Thank you for your participation and have a wonderful day. Attendees, you may now all disconnect.

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Reynolds American, Inc. (RAI): Q4 EPS of $0.77 misses by $0.04. Revenue of $2.04B (-1.9% Y/Y) misses by $30M.