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Executives

Daniel Delen - Chief Executive Officer, President, Director, Chairman of R J Reynolds Tobacco, Chief Executive Officer of RJR Tobacco and President of RJR Tobacco

Thomas Adams - Chief Financial Officer and Executive Vice President

Morris Moore - Vice President of Investor Relations

Analysts

Bonnie Herzog - Wells Fargo Securities, LLC

Judy Hong - Goldman Sachs Group Inc.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Christine Farkas - BofA Merrill Lynch

Ann Gurkin - Davenport & Company, LLC

Matthew Grainger - Morgan Stanley

Vivien Azer - Citigroup Inc

Karen Lamark - Federated Investors

Nik Modi - UBS Investment Bank

Reynolds American (RAI) Q2 2011 Earnings Call July 22, 2011 9:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to Reynolds American Second Quarter Earnings Conference Call. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to introduce Mr. Morris Moore, Vice President of Investor Relations. You may begin.

Morris Moore

Good morning, and thank you for joining us. Today, we'll discuss Reynolds American's results for the second quarter and first half, as well as our revised outlook for the full year. We'll focus our discussion on adjusted results as management believes this better reflects the underlying business performance. A reconciliation of reported to adjusted earnings is in our press release, which is on our website at reynoldsamerican.com.

With 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 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 statement. and now I'll turn the call over to Dan.

Daniel Delen

Good morning, everyone. Reynolds American delivered higher earnings in the second quarter as its operating companies key brands made additional gains despite the challenging economic and competitive environments.

Both of our reportable business segments continue to execute their business strategies effectively. With R.J. Reynolds growth brands increasing their combined market share and American Snuff reporting excellent growth in volume, share and operating margin.

At Santa Fe, I'm pleased to say second quarter results were strong. Once again, the company generated growth in volume, share and earnings. As we reported today, RAI's first half results allowed us to tighten our earnings projections for the full year.

RAI and its operating companies continue to demonstrate strength and resilience despite significant competitive activity in the second quarter and the ongoing weak economy.

As a result, we remain on track to deliver 2011 adjusted EPS growth in the mid- to high-single digits. This range excludes the charge for the Scott smoking cessation lawsuit in Louisiana, as well as implementation costs related to plant closings and tax items recognized in the first half of the year.

Over the long term, our strategy is straightforward and bold. RAI and its operating companies are focused on leading transformation of the tobacco industry, while continuing to deliver outstanding results for our shareholders. We continue to drive innovation across our businesses, with a commitment to redefining enjoyment for adult tobacco consumer.

Now I'll provide additional details on our operating companies. R.J. Reynolds' second quarter adjusted operating income was down slightly in both the second quarter and for the first half. Gains in the company's growth brands were offset by cigarette volume declines in its support and non-support brands. The cigarette category continues to demonstrate good pricing power as evidenced by the price increase that R.J. Reynolds took early this month.

I would also note that R.J. Reynolds remained focused on achieving the right balance between profitability and market share growth. Competitive promotional activity increased significantly with the timing of promotional cycles in April and May, while R.J. Reynolds had relatively normal promotional levels in the quarter.

The company's total second quarter cigarette market share was down half a percentage point at 27.4%. However, if we exclude the private label brands that have been delisted as part of the company's portfolio simplification efforts, it's total cigarette market share was in line with the prior year quarter at 27.3%.

R.J. Reynolds' growth brands, Camel and Pall Mall, continued to perform well in the second quarter. Their combined market share increased 1.5 percentage points from the prior year quarter to 16.3%. And these 2 brands accounted for almost 60% of the company's total cigarette volume in the quarter.

Camel's second quarter cigarette market share was steady at 7.8%, which is good performance, especially for premium priced brand in this challenging environment. R.J. Reynolds continue to focus on building brand equity for Camel. The brand's most recent promotion, the Hump Day Sweepstakes campaign started in March. And the response from adult tobacco consumers to this web-based initiative have been nothing short of fantastic.

Indeed, this is the company's most successful promotion in recent years, with more than 1 million visits to the brand's websites. A key driver behind Camel's performance is its menthol styles, which use R.J. Reynolds' innovative capsule technology. Camel share of the growing menthol market increased by 0.3 of a percentage point in the second quarter and now stands at 2.1%.

R.J. Reynolds will continue to build momentum with next week's national expansion, Camel Crush Bold. This one additional SKU also uses the capsule technology and offers a richer, more full-bodied tobacco taste. I would also point out that this is R.J. Reynolds' first new national cigarette line extension since Camel Crush went national 3 years ago.

The company expects this new style to drive additional growth and further broaden the appeal of the Camel brand.

Now moving to Camel's modern smoke-free tobacco products. Camel SNUS again performed well in the second quarter. Its interest continues to grow in this convenient smoke-free option for adult tobacco consumers. As we mentioned last quarter, R.J. Reynolds introduced 2 new Camel SNUS styles in lead market, SNUS mint and Frost Large. Although they've been in the markets for only one quarter, they're showing encouraging results. These 2 styles offer adult tobacco consumers more options to try and ultimately switch to this innovative product.

In addition, the company launched the Camel SNUS Pleasure Switch Challenge promotion, which is also increasing the brand's awareness and trial.

On Camel's line of dissolvable tobacco products, these products, Orbs, Sticks and Strips, were refined and improved and introduced in 2 new lead markets in March. The products are attracting good consumer interest and the company continues to gain valuable insights about this new category.

Now turning to R.J. Reynolds second growth brand. Pall Mall reported another excellent quarter, delivering double-digit volume growth and increasing its market share by 1.5 percentage points. The brand achieved an 8.5% share of market for the quarter. This high-quality, longer-lasting cigarette has proven to be a very popular choice for adult smokers taking value, especially in this weak economy.

This distinctive blend of quality and value offers a strong foundation for Pall Mall's long-term success. So in summary, R.J. Reynolds demonstrated strength and resilience in the face of some strong headwinds in the quarter and is well positioned for growth in the remainder of the year. Now turning to American Snuff.

I'm pleased with the company's solid underlying performance in the quarter despite low price line extensions of premium brands and significant promotional activities on deep discount brands. I would note that the sale of Lane in February negatively impacted the earnings comparison for the quarter, and Tom will give you more details on that in just a moment.

American Snuff's second quarter moist-snuff consumer offtake share performed extremely well, increasing 1.5 percentage points from the prior year quarter to 31.3%. This performance was driven by the company's flagship brand, Grizzly, which reported strong gains in both volume and share. Grizzly's momentum continued in the second quarter, with consumer offtake share increasing by 1.9 percentage points from the prior year. Grizzly now holds a 27.4% share of market. The brand continues to benefit from the strength and scale of R.J. Reynolds field trade-marketing organization that now also serves American Snuff.

Addition, the new retail moist snuff contracts that were introduced in the second quarter are giving Grizzly more retail space, as well as improved brand and pricing communication. This investment has better positioned the brand for continued long-term growth. And American Snuff continues to invest in the equity of Grizzly with promotions like its current "giving it to you straight" sweepstakes, which engages adult tobacco consumers in an exciting web-based campaign.

And the brand is planning activities to celebrate its 10th anniversary by September. Grizzly's post sales continued to be a key factor in the brand's strong performance. The growing pouch segment accounts for more than 9% of the moist-snuff category. Grizzly has also seen rapid growth in its pouch styles since their introduction just 3 years ago. I'm proud to say that Grizzly Wintergreen Pouches are the best-selling pouch styles in the market.

In summary, both American Snuff and R.J. Reynolds continued to successfully leverage their sound business strategies and grow their key brands while navigating through a challenging environment. Now Tom will provide some additional financial details. Tom?

Thomas Adams

Thank you, Dan. Good morning, everyone. During my discussion, I'll focus primarily on adjusted results to provide perspective on our underlying business performance. Reconciliations of adjusted-to-reported results are in our press release, which is on our website. RAI have a solid quarter posting adjusted earnings per share of $0.67, up 1.5%. Higher pricing and moist-snuff volume gains more than offset cigarette volume declines. These adjusted results reflect the impact of the Lane sale and exclude a charge of $0.15 per share related to the Scott lawsuit.

On a reported basis, RAI second quarter earnings per share was $0.52, down 10.3% from the prior year quarter. For the first half of 2011, adjusted earnings per share was $1.26, up 4.1% from the prior year period. This adjusted results exclude the second quarter charges I just mentioned, as well as first quarter tax items.

In addition, there were prior year charges for plant closings and the single sales force implementation. RAI's second quarter adjusted operating margin was 30.1%, in line with the prior year quarter. First half adjusted operating margin was 29.9%, up 0.5% from the prior year period.

Now turning to R.J. Reynolds performance. The company's second quarter adjusted operating income was $562 million, down $6 million from the prior year quarter. Higher cigarette pricing, productivity improvements and growth-brand gains were offset by the decline in support and nonsupport cigarette volume. These adjusted results exclude $139 million for the Scott lawsuit, as well as $3 million in implementation costs related to plant closing.

For the first half of 2011, R.J. Reynolds' adjusted operating income was $1.03 billion, down 0.5% from the prior year period. This first half adjusted results also exclude the charges I just mentioned.

R.J. Reynolds second quarter adjusted operating margin declined 0.6 of a percentage point to 28.7%. And that brought the first half adjusted operating margin to 28.3%, in line with the prior year period. I would note the second quarter margin was negatively impacted by an increase in R.J. Reynolds' contract manufacturing for the BAT Japan. Disruptions from the natural disaster there in March drove higher demand for BAT products sourced by R.J. Reynolds.

Excluding that impact, second quarter margin was in line with the prior year period.

Turning to cigarette shipment volume. R.J. Reynolds' second quarter cigarette shipment volume declined 4.4% from the prior-year quarter. Volumes were negatively impacted by the timing of competitive promotional activity in the quarter. If you exclude the company's delisted private label brands, volume was down 3.6% while the industry's second quarter volume declined 1.3%.

However, I would note that industry's cigarette inventories, as wholesale, increased significantly during the quarter. I would remind you that R.J. Reynolds has a policy to minimize wholesale inventory fluctuations.

Now turning to American Snuff's second quarter results. The company's operating income was $81 million, down 4.7% from the adjusted prior-year quarter. Here I would note the prior-year quarter did include about $10 million from the Lane business, which was sold in February this year. American Snuff also made investments in the implementation of new retail moist-snuff contracts.

For the first half of 2011, the company's adjusted operating income was $168 million, down $1 million from the prior year period, which included a full 6 months of earnings from Lane. First half adjusted results exclude $2 million in implementation costs. American Snuff's second quarter operating margin increased by 5.5 percentage points from the adjusted prior year quarter to 52.4%. I would note the margin did benefit from the timing of promotional spending in the prior year related to the introduction of embossed metal lids on Grizzly.

That brought first half adjusted operating margin to 52.3%, up 3.1 percentage points. Turning to moist-snuff volume. American Snuff increased moist-snuff shipment volume by 3.6% in the second quarter, bringing the first half shipment volume gain to 8.1%. Underlying industry volume growth has remained at about 6% this year.

Grizzly's second quarter shipment volume also increased despite strong competitive activity rising 4.7% from the prior year quarter. All in all, the brand's first half shipments were up 10.4%.

Kodiak, the American Snuff's premium priced brand, delivers stable volume performance in the quarter.

Now I'd like to turn to RAI's balance sheet.

Reynolds American ended the quarter with cash balances of $1.3 billion and this was after making the $1.96 billion MSA payment in April. The company also continued to strengthen its balance sheet, with a debt repayment of $400 million in June.

We remain committed to delivering value to our shareholders, with our targeted dividend payout ratio of 80%. And we remain focused on evaluating opportunities to return additional value to shareholder.

Based on RAI first half performance and a positive momentum we expect over the rest of the year, we've raised the bottom end of our adjusted 2011 earnings per share guidance to a range of $2.62 to $2.70. This excludes the Scott lawsuit charge and the implementation costs related to plant closings and tax items.

Also excluded from this estimate is any potential impact from the Engle progeny cases. We are currently reviewing the financial implications at this week's decision by the Florida Supreme Court. Thank you, and now we'll 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

[Operator Instructions] Our first question comes from Vivien Azer from Citigroup.

Vivien Azer - Citigroup Inc

My first question has to do with the outlook for accelerating growth in the back half of the year, while I can perfectly appreciate the pressure, the competitive activity you had on your operating profits this quarter, is there anything that you saw through the course of 2Q that gave you confidence that either a competitive activity is backing off little bit or if cost savings are coming in that can help us get comfortable with that acceleration in the back of the year?

Daniel Delen

Vivien, thank you for your question. I think the way that I would kind of describe the dynamics this quarter is coming into the quarter. I think there was heavy competitive pressure certainly in the months of April and May. And towards the back end of the quarter, I think it sort of returned to normalized levels. So the way I would describe the competitive environment is there was some significant sort of competitive fighting of the promotions during the quarter. That obviously gives me significant confidence going forward, given how we, as a company, with our brand portfolio actually withstood some of the competitive pressure and very confident in the underlying dynamics of our brands, especially given some of the demographic changes we continue to see in the business on those brands.

Vivien Azer - Citigroup Inc

That's very helpful. My second question has to do with litigation and specifically the Scott case. One of your key competitors reported earlier this week and they actually included that charge. In earnings, I was hoping you could just give a little color on your discussion to exclude.

Daniel Delen

Yes, I think, obviously, related to the Scott case, we were denied the Supreme Court certification. The judgment on our side was $139 million. I just, as a perspective, and why our number's quite high on that side is we carry the litigation and liability, both for Brahna Wames [ph] and for R.J. Reynolds tobacco. Of course, we were disappointed frankly we believe it was a wrong judgment. But I think most important here is that it's not precedent setting and really the issue that's at stake there was specific to the state of Louisiana.

Operator

Our next question comes from Chris Growe from Stifel, Nicolaus.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

I had 2 questions for you, if I could. I want to understand within the Camel performance, you indicated that there was about 30 basis points benefit to your share from menthol. With Camel SNUS and I guess the dissolvable products as well were those incremental to your Camel share this quarter was there a comparison factor with those for not helping your overall Camel share?

Daniel Delen

No, we don't actually include the Camel SNUS of volume within that number. That market share is specific to Camel cigarette.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Okay. Good. I just want to make sure of that. And the second question is in relation to your smokeless category -- in relation to the smokeless category performance, rather than your own, your own is quite strong. But indicated the category was flattish or so in the quarter, I want to understand if that's more of a timing factor, if you think there's any other issues there, if you will, within the smokeless category that resulted in the weakness -- the slowdown this quarter?

Daniel Delen

No, I think the way I would kind of describe the quarterly dynamics is this way, if we take a look at it year-on-year as a category, we're actually believe it was up by just over 6% year-on-year. Now of course, if you look at our performance, the first quarter was very strong from a volume growth point of view and the second quarter sort of more normalized. But even when we look at the year-to-date numbers from an industry point of view, there's still the official a sort of volume shipments coming in at 9% up year-on-year at first half to first half.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Okay. That's very helpful. And then the final question I have for you, this is in relation to cigarette inventories. And are you able to quantify what you think will sort of be taken out of inventories in the third quarter based on the build in the second quarter. I know you try to minimize those but I'm sure there was some incremental inventory for you?

Daniel Delen

Let me kind of maybe explain some of the inventory dynamics, and I'll provide a little bit of a perspective on what's going on. I think first of all, it's worth kind of noting why wholesalers actually build inventory. There was during the quarter, in the back end of the quarter, particularly, there was price increase speculation on behalf of the wholesalers. And in addition to that, some of the wholesalers, they needed extra inventory to cover the 4th of July holiday. Of course, the 4th of July happens every year so you would expect that part of it's within the numbers. And we as a company have an ongoing policy to really limit the price speculation and we do that by basically placing wholesalers on allocation and just making sure that we minimize any fluctuations in the supply chain. And the reason we do that is because it obviously has an adverse impact on our operations and on the entire supply chain so to keep everything as efficient as possible. So from an impact point of view, I think it's fair to say that the industry -- sort of inventory that was built as wholesale, we were underrepresented within that. And we did our best to limit inventory build to only what was required for the 4th of July holiday. Now maybe just to underscore that point, if we look at our business to date now in July, I would say that we've seen a normal levels of shipment post the 4th of July holiday. And I think one other factor is quite important when we think about the inventory side of things. When that is actually shipped, you get full list price for the volume that's actually shipped. But the value of the promotional dollars attached to that volume, they only sort of hit the company when it's actually shipped from wholesale to retail. So really building inventories is at full margin.

Thomas Adams

Chris, this is Tom. Just to dimensionalize this. I think I mentioned that the end of the first quarter that we had about 300 million Sticks that were actually de-loaded by the wholesale trade. And as Dan said, the 4th of July, we're up probably about 200 million, which actually, if you dimensionalized it, it's about a little bit less than a day's worth of our shipments. So that's, just kind of put some context around that.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

And the 200 million Sticks of this sequentially from the end of the first quarter, is that correct?

Daniel Delen

No, that would be in above our normal inventory level.

Operator

Our next question comes from Judy Hong from Goldman Sachs.

Judy Hong - Goldman Sachs Group Inc.

Tom, can you quantify the impact of the BAT contract manufacturing in the quarter both sales and profit?

Thomas Adams

I'm not going to give you specific dollars but the margins that we received on that were actually lower than the margins that we have for the cigarettes that we sell domestically. What is compressing the margins is that we airfreighted a significant amount of cigarettes to Japan on BAT's behalf. We're naturally reimbursed for that but that number with those in sales and cost of sales, and so that actually kind of depressed the margins. In order of magnitude, it was probably in the $30 million range.

Judy Hong - Goldman Sachs Group Inc.

$30 million to your -- a hit to your cost? Okay. But I guess that would've also added to your sales, right? Just in terms of...

Thomas Adams

Yes, it would. Yes, it would.

Judy Hong - Goldman Sachs Group Inc.

Okay. Is there anyway to quantify how much it added to your sales? I'm just trying to understand how pricing per unit behaved in Q2 for your underlying cigarette business. And if I look at your net revenue, it looks like that's including the contract manufacturing sales, while the volume number doesn't, so it just seems like I'm comparing apples to oranges here.

Thomas Adams

If you look at the financial statements that are part of the press release, Judy, there's a line item in there that talks about related party sales, that's $139 million, I believe. And that's the sales to BAT and with $108 million in the year-ago quarter.

Judy Hong - Goldman Sachs Group Inc.

Okay. All right. I'll look at that. And then just in terms of Grizzly, Dan, it seems like you've really seen a much stronger growth in the last couple of quarters. You've talked about the sales organization. Can you go into a little bit more just in terms of exactly what kind of traction you're seeing and the sustainability of Grizzly's performance?

Daniel Delen

I think we really see Grizzly continuing to go from strength to strength. If we take a look at the year-on-year change in market share, it's up for the quarter, 1.9 market share points. And I do believe a significant part of that is due to the field force and really the servicing of its trade marketing efforts through our charity. And when I look at that brand, I think 2 things happening. It's really what the trade marketing effort now is doing. It's really fully exploiting what already were some of the inherent strengths of the brand. We've talked many times in the past about the growing equity that we continue to see on the brand. And then fundamentally, it's a great product with some great packaging now with the metal-lid upgrade at a very reasonable popular price. and I think it's just -- it's hitting on all cylinders as we speak. and I think there's still more to come in terms of that growth, particularly around some of the field force efforts. And the way I would describe that is, of course, we launched a new retail contract at retail. And we have many more feet on the street now servicing the brand. But getting those new retail contracts and one thing is actually signing the contract, the second part of that is actually implementing and executing. And from that, we continue to see ongoing benefit.

Judy Hong - Goldman Sachs Group Inc.

Okay. And then just on the FDA menthol update, do you have a better view in terms of the timeline of what we're looking for now from the FDA perspective? I guess they have -- they started the external peer review in July. 3.5 months after, they're supposed to come back with some conclusion and issue a preliminary scientific assessment. Is that basically the initial proposal that we will get the 60-day public comment period, and then you'll get the final proposals sometime thereafter. Is that how the timeline you see it playing out as it relates to the FDA menthol?

Daniel Delen

Two things. Just one, maybe as perspective for some of the other people on the call, is that the FDA has basically undertaken exercise now to do what is called a peer review of the science around menthol in cigarettes. They are under no obligation at this stage and there's no statutory deadlines or anything like that for this process or for final decision making. So really I can't give you a better perspective at this stage.

Operator

Our next question comes from Nik Modi from UBS.

Nik Modi - UBS Investment Bank

Just a couple of quick questions. Tom, I hate to bother you again with this question but just thoughts on -- your balance sheet obviously looks healthy. You talked about 1 and 2 add value, just curious on your perspective thoughts on a buyback and then I just have 2 other questions.

Thomas Adams

Okay. Well, I mean, I'm going to reiterate a bit what I said back in April and that is that we continue to have some heavy capital spending, probably you'll see. When we filed our Q, we spent about all over $90 million in the first half. We're going to spend a little over $200 million for the year and then a bit on capital projects, principally the projects at American Snuff for the leased processing facility and the new plant in Memphis. We also have in our plans as we've disclosed about $300 million pension plan contribution that we'll make in the back half of the year for some number of order of magnitude close to the $300 million. And then we've unfortunately have the Scott case, that $139 million that Dan has talked about. And so we do have some requirement on our capital for -- within the near term. And we've also just paid down -- we've paid down debt but that was actually in the balance of $400 million. Now to your point that does put us right at the bottom end. It's actually slightly below our range of debt to EBITDA that we'd like to operate in, which is 1.5 to 2.5. But you also need to kind of kick in there is pension deficit which is roughly $0.5 billion. So we're really looking at we're kind of 1 7. And we're mindful of that. We understand that we have some abilities to borrow and that the rates are favorable. And we discussed all these things with our Board of Directors. And we also discussed with them ways to increase money that we can get back to shareholders, including share repurchases. And that's about what I can tell you and when -- and I'll let you know what they decide when they reach a decision.

Nik Modi - UBS Investment Bank

And then quickly, maybe, Dan, if you can talk about the marvel of leadership price program obviously haven't been rolled out in April, how that has affected your business. I mean to some degree is there some understanding that most of the other major manufacturer with contracts would actually benefit as well as the fair and equitable clause would lead the retailers to cut prices on some of your brands as well. So just any thoughts around the MLP program. And then the last question is, on the Grizzly, new Grizzly contract, can you provide some context on exactly kind of the amount of money you may be investing and kind of what's the requirements are at retail, That will be very helpful.

Daniel Delen

Sure, Nik. Let me take those questions just in terms. First of all, on the MLP, this is a latest iteration of the trade program and we have seen many trade programs over the years they kind of come and go. And most trade programs when they're launched, and I think the MLP is no different to that. You get a certain level of people, retailers basically signing up form. And then over time, what you see is more and more people kind of joining the program. And that's very normal kind of trade behavior over time, and this go around has been no different. Now what all trade programs tried to do is they try to split the world between retailers that are on the program and retailers that aren't. And so fundamentally, I don't think there is a significant change in the aggregate kind of dynamics out of retail. And when I kind of look at the second quarter specifically, what maybe had a more significant impact on our business was actually the absolute number of dollars spent back in the marketplace, not so much where and what retailers against what the trade program. And just to reiterate some of the comments I made earlier, that spent competitive spent increased in the early part of the quarter, specifically in the months of April and May and then came down to more normalized levels in the month of June. So that's really it on the cigarettes side. I think on the moist-snuff side, the way I would characterize our trade program, it's a fairly standard, fairly normal kind of trade program. All we're really doing is incentivizing retailers to give Grizzly it's fair share of presence at retail. And by presence, I really mean the right number of facings at retail, given the size of the brand and the right level of signage and also price communication. So I think really what we're incentivizing is basically a catch-up were historically, the American Snuff company was a very much fewer people out in trade marketing. It wasn't able to command the presence of the brand Grizzly specifically deserved. And so we're really just kind of playing catch-up as we speak, and I think doing that quite affectively which is reflecting in a very positive momentum on the brand.

Operator

Our next question comes from Bonnie Herzog from Wells Fargo.

Bonnie Herzog - Wells Fargo Securities, LLC

I just had a quick question on your Santa Fe brand. It was quite strong in the quarter. Could you just give us a little bit more color on that brand, maybe what share is that right now? Maybe some finishes you have with the brand internationally?

Daniel Delen

Sure, Bonnie. I think first of all, this obviously is not a reportable segment for us. But certainly, I'm very happy with the performance of that company in the quarter and frankly, over the last years that the brand and the company keeps going from strength to strength. And it's really posting sort of double digit volume, share and operating income growth. And I think given the current economic environment out there, the way that this is super premium brand has been able to buck the trend is remarkable and very noteworthy. On the international side, I think, it continues to progress nicely but it is a very, very small part of the business. But it has a small but not insignificant in growing share in some key markets like Germany, Switzerland and Japan.

Bonnie Herzog - Wells Fargo Securities, LLC

All right. And then, I just wanted to clarify, you mentioned that you're taking Camel Crush Bold national, I think, in this quarter, in the third quarter?

Daniel Delen

Correct.

Bonnie Herzog - Wells Fargo Securities, LLC

Was that already shipped? Or what's the timing of rolling that out nationally?

Daniel Delen

I believe most of the shipments actually happened this quarter. It's rolling out next week. And obviously, we're quite confident. If you take a look at Camel, the menthol portfolio within the Camel brand actually achieved 2.1 market share points in the quarter and believe this will help further accelerate growth on the menthol styles of Camel.

Operator

Our next question comes from Matt Grainger from Morgan Stanley.

Matthew Grainger - Morgan Stanley

Just 2 questions. First, could you provide any additional context around Pall Mall's retail share and given the heightened level of competitive activity during the quarter, I know you've highlighted a more normal levels of promotion on your brands, but I'm assuming you responded to some extent. Why do you think the brand wasn't able to show some degree of sequential growth for the first quarter in quite a while? And does this reflect any further shift in your relative level of promotional support between the 2 growth brands?

Daniel Delen

No, here's kind of how I would describe the quarter for Pall Mall, is you're right, that it was relatively stable sequentially. It's still up 1.5 share points when we look at it year-over-year. And on the year-to-date numbers, so first half to first half was actually up 1.7 share points. I think it's fair to say that it was impact for at least its growth was slowed by some of the competitive activities and the timing of some of those promotional cycles from our competitors in the early part of the quarter. I think Pall Mall is fundamentally a very strong proposition in the marketplace, especially in today's economic environment. We continue to see the positive retention numbers. And I've quoted some of these numbers in the past, the 50% sort of a trial to conversion, which is phenomenal and really second to none in the marketplace. So very happy with that. and I think what's really impacted the brand in the quarter some of the competitive promotional cycling going through the marketplace. And quite confident that Pall Mall can continue to grow into the future.

Matthew Grainger - Morgan Stanley

And can you give us any sense of where its retails shares during the month of June with respect to the timing of the competitive promotions?

Daniel Delen

No, Matt. Actually, we don't release a monthly market share numbers and just rely on the quarterly figures, which I've quoted to you.

Matthew Grainger - Morgan Stanley

Okay, understood. And then one final question. I just wanted to get your current thoughts on the arbitration of the 2003 disputed MSA payments. And if you could maybe address just how optimistic you are on the prospects of potentially resolving this through a settlement rather than fully resolving it to the arbitration.

Daniel Delen

Well, the way I would describe it is first of all is very happy that we finally got to the arbitration process, got that all started. And very happy with the actual panels, the actual arbitrators that were chosen and they're leading the process. They appear to have outlined a good process to actually bring this to resolution. And so in aggregate, I'm quite optimistic about the eventual resolution of this, and of course, it's taking longer than we would like what these things always do. And so really, I think I'm very optimistic that if we need to rely on the arbitration process that, that will lead to a good conclusion for us as a company. Just a point of background that what's really being arbitrated this stage is the only 2003 monies in dispute. So really, no matter how this settles in the future, I think either path, and I'm quite optimistic.

Operator

Our next question comes from Ann Gurkin from Davenport.

Ann Gurkin - Davenport & Company, LLC

Given the mess in the quarter, can you go through again your confidence in raising the lower end of the guidance? I know you came out of the quarter with a bit of feeling about the competitive environment, what gives you the confidence to lift that low end, given the Q2 mess?

Daniel Delen

Well, I just think we kind of look and obviously we project forward a lot of the expected competitive activities and that's obviously what we market against. But fundamentally, we'll look at the strength of our own business, the strengths of our brands and obviously we have insight into some of the plans going forward and that allows us to make a optimistic projection going forward and allowed us to raise the bottom end of our guidance.

Ann Gurkin - Davenport & Company, LLC

But what happened this quarter going to this quarter you all misread the competitive environment?

Daniel Delen

No, here's the way I would kind of describe it is what happens in our category is we see sort of timing of the cycling of competitive activities. And one of those -- some of those a significant competitive activities just happen to hit in the first -- early part of the quarter. Of course, we're not -- we can't predict and we're not in charge of competitive business but those things happen, and we can swing and roll with the punches.

Ann Gurkin - Davenport & Company, LLC

And then in the release and your comments about the business, you talked about ongoing economic weakness has that worsened or changed since you started the year. Can you give an update on your outlook there?

Daniel Delen

Well, I think, really if you take a look and we're obviously part of the entire economic environment, and one of the ones that we've talked to you about in the past is actually the impact that gas prices might have on cigarettes, not so much in terms of total industry volume but certainly it has an impact on the psyche of the consumer. If they just finished filling up their tank at the pump at significantly increased prices, they're in a very price-sensitive shopping moment when they actually go into the store to buy their cigarettes. And so what we do see is the economic environment having an impact really on the up trading or down trading kind of environment within the category, even though the total category of volume remains pretty close to expectation.

Operator

Our next question comes from Karen Lamark from Federated Investors.

Karen Lamark - Federated Investors

Question about your support brands. You might have answered it with Chris' questions whereby you underrepresented at wholesale but with the weakness in those volumes I wonder if you can share any other color on what might have been going on, did you reallocate resources, was there an execution issue?

Daniel Delen

I mean the way I would kind of describe the performance of our support brand portfolio is really come back to some of the competitive dynamics. Those our brands that we have some spend on but not significant spend on those brands and when there are significant competitive activities in the marketplace, those brands tend to be impacted more, and it's really from 2 points of view as, a, because we don't spend as much -- don't give them as much care and attention as the growth brands of the portfolio. And secondly, in aggregate, some of the consumer dynamics and demographics on the brand, they tend to have older and therefore, slightly more price-sensitive smokers.

Karen Lamark - Federated Investors

Okay. And then a separate question just to confirm, so you're updated guidance does not include any assumption of buybacks. Is that true?

Thomas Adams

It is correct.

Operator

Our next question comes from Priya Ohri-Gupta from Barclays Capital.

Priya Ohri-Gupta

I think you may have answered this question actually with in response to Ann just now. But can you speak to the industry trend in which sort of the premium to total mix has actually ticked up year-over-year this quarter?

Daniel Delen

I'm sorry, could you repeat the question?

Priya Ohri-Gupta

Sure. Can you speak to the rationale behind the industry premium to total mix ticking up year-over-year this quarter? It sort of moved to 71.4%, up from 70.5%? Can you just talk about the dynamics behind that?

Daniel Delen

Yes. And the reason I kind of hesitated a little bit when you asked the question, I think it all comes down to what your definition of premium actually is within the category. Of course, the way historically it's been done in our category is up by just placing specific brands in either the premium or the value category. But increasingly, what you see in the marketplace is value line extensions to premium brands and when you look at the marketplace of that way in terms of the effect of price actually paid by consumers, I think it's fair to say that there's a down trading trend in the category and has been for a couple of years now.

Priya Ohri-Gupta

Also can you just speak to your thoughts around industry consolidation, given sort of the trend that we're seeing broadly in other sectors as well?

Daniel Delen

Really, I don't have any comment to make at this time on any sort of potential speculative M&A in the category.

Operator

[Operator Instructions] Our next question comes from Christine Farkas from Bank of America.

Christine Farkas - BofA Merrill Lynch

Tom, a question on other margins. We did see that spike up and just looking at the discussion of the margins, I'm not sure if you addressed that. Can you talk to what specifically drove that segment profit this quarter?

Thomas Adams

Yes. Some of the profits were attributable to Santa Fe, actually probably the lion's share with Santa Fe. And then we also had a basically a recovery in some monies and it was actually rather minor but that was in there as well. But it was largely Santa Fe.

Christine Farkas - BofA Merrill Lynch

Okay, that's helpful. And then other question, Dan, just on elasticity, we've seen pricing put in place now at the beginning of the July period, and I realized it's still really early. But could you comment at all based on what you see with the environment and the macros, how you think or if you think elasticity is changing at all?

Daniel Delen

No, I think really our analysis of it is that price sensitivity of demand has held remarkably stable really through this economic downturn. Of course, we see an impact in that premium to value mix of the category as a whole. But I think really it's held remarkably constant throughout this crisis. Maybe just while I'm on the subject because you mentioned the price increase, which obviously we took at the beginning of this month. But in addition to that, I think the excise environment has been significantly more positive than frankly we predicted at the beginning of the year. And I know I went out beginning of the year and sort of gave this $0.15 to $0.20 kind of estimates and having to regularly sort of revise down my estimate. And the latest estimate I provide you with is that we're expecting the year average to come in at less than a $0.05, which is a very positive development. But obviously it's something that impacts the consumer as would a manufacturing price increase. And so I'm happy to kind of report that improving trend on that side.

Christine Farkas - BofA Merrill Lynch

Just on the number then less than $0.05, that would be for calendar 2011 rather than the fiscal year start?

Daniel Delen

That's correct.

Christine Farkas - BofA Merrill Lynch

Okay. And then, of course, with slowing taxes that also could mean less opportunity to take pricing should we connect the 2 or this is just maybe even more flexibility than you thought you might have had?

Daniel Delen

I'd say the latter rather than the former.

Operator

If there are no further questions, I would now like to turn the conference over to Mr. Moore for any additional remarks.

Morris Moore

Thank you for joining us today. If you have any additional questions, please contact us at Investor Relations.

Operator

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

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