Reynolds American's (RAI) CEO Susan Cameron on Q3 2016 Results - Earnings Call Transcript

| About: Reynolds American, (RAI)

Reynolds American, Inc. (NYSE:RAI)

Q3 2016 Earnings Conference Call

October 19, 2016 09:00 AM ET

Executives

Robert Bannon - Vice President, Investor Relations, Reynolds American, Inc.

Susan Cameron - President, Chief Executive Officer and Director

Andrew Gilchrist - Chief Financial Officer and Executive Vice President

Debra Crew - President and Chief Operating Officer, R.J. Reynolds Tobacco Company

Analysts

Vivien Azer - Cowen & Co. LLC

Matthew Grainger - Morgan Stanley & Co. LLC

Nik Modi - RBC Capital Markets LLC

Adam Spielman - Citigroup Global Markets Ltd.

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

Michael Lavery - CLSA Americas LLC

Bonnie Herzog - Wells Fargo Securities LLC

Megan Cody - UBS

Operator

Good morning. My name is Jenese, and I will be your conference operator today. At this time, I would like to welcome everyone to the Reynolds American Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

Vice President of Investor Relations, Bob Bannon, you may begin your conference.

Robert Bannon

Good morning and thank you for joining our call. Today, we'll review Reynolds American's results for the third quarter and nine months, as well as our revised outlook for the full year. As usual, our discussion will include adjusted non-GAAP results as management believes this provides additional perspective on our underlying business performance. RAI's use of adjusted measurements are intended to be supplemental in nature; and should not be viewed as a substitute for reported GAAP results.

Our press release includes an explanation of our use of adjusted EPS guidance and reconciliations of reported to adjusted results. Our press release is available on our website at reynoldsamerican.com.

Joining me this morning are RAI's President and CEO, Susan Cameron; R.J. Reynolds’ President and COO, Debra Crew, who as you saw this morning has been named RAI’s President and CEO elect; and we also have Andrew Gilchrist, 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 or cautionary statements. I'd also remind you that RAI's website is our primary source of publicly disclosed news, and that we also use Twitter to disseminate company news.

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

Susan Cameron

Thank you, Bob. Hello, everyone. Well, we do have plenty of news today, don’t we? But before I speak to the upcoming changes in leadership here, let me touch on a few of the quarter’s business highlights. First, our operating performance continued to be excellent, especially in light of the significant investment in our company’s regulatory compliance, innovation pipeline, and participation in current state political processes.

In addition, both Newport and Natural American Spirit made another impressive showing in the marketplace, and together with higher pricing in both cigarette and moist snuff these premium brands were a key driver behind RAI’s strong earnings growth for the third quarter and the first nine months.

Over the course of the year we have also accelerated returns to our shareholders, and I'd remind you here of our significant debt reduction, two dividend increases and RAI’s new share repurchase program. So I am very pleased with the way this year has progressed and with Newport’s integration now behind us this is an appropriate time to layout our leadership succession plan. As we announced today I will become Executive Chairman of RAI on 1st of January; and Debra will succeed me as President and CEO. Yes, I really am retiring as CEO this time, and I have assured my husband there will be no round three.

But I am fully committed to making a seamless and successful transition with Debra over the next few months, and as Board Chair I look forward to playing an integral role in RAI’s future success. Not only is this the right time for a transition to a new role but Debra is absolutely the right person to lead RAI and its companies to the next level. Debra has years of experience and leadership in the consumer products industry and she has made a significant impact since joining R.J. Reynolds two years ago, playing a critical role in Newport’s integration into our company's portfolio and helping to drive innovation throughout RAI’s businesses.

Debra and I have worked closely over the past two years and I am confident that Debra will successfully build upon the strong foundation for our businesses that we have formed together following the Lorillard acquisition. I also want to welcome Joseph Fragnito from the Kraft Heinz Company to RAI’s leadership team. Joe, an experienced brand marketer and innovator, will take over as R.J. Reynolds’ President and Chief Commercial Officer next week. We will be giving you a full update on our plans to continue growing our businesses and advancing our transforming tobacco agenda at our investment day event in November.

So for now I will hand over to Debra for more details on our third quarter report.

Debra Crew

Thank you Susan. It is great to be here and I am excited to be given the opportunity to play a bigger role in RAI’s ongoing success. It has been a true pleasure over the past two years working with our talented team, gaining a deep understanding of the tobacco industry as well as directly contributing to the success of our strong businesses and powerful brands. I would also like to welcome Joe and his expertise and experience to our team.

From his work at Kraft Heinz he knows how to run effective and efficient business units in addition to his experience in consumer packaged goods. Joe also comes to R.J. Reynolds with a strong track record of bringing brand innovations to market, which will serve the company well moving forward. In addition to working closely with Susan on the CEO transition, I and the rest of the leadership team look forward to working closely with Joe as we continue to build our company’s businesses and execute upon our successful strategies now in place.

Now let us turn to our operating companies’ results. I'm sure you have all read our earnings report. So I just like to touch on the third quarter highlights and key takeaways. I will start with Combustibles. We continue to see a positive macroeconomic environment for adult tobacco consumers in the third quarter. But we are now lapping the impact of those positive tailwinds on industry cigarette volumes and we are seeing industry volumes returning to a more normal rate of decline.

On an inventory adjusted basis, industry cigarette volumes declined by about 3.4% for the quarter and about 1.8% for the first nine months. Given this our current view for the full year is that cigarette volumes will be down around 2.5% and looking ahead we continue to expect cigarette volume declines to track within their historical range of down 2% to 4%.

For RAI’s operating companies, total third quarter cigarette volume was down by 1.5% from the prior year quarter and wholesale inventory changes did not have a significant impact on our operating companies in the quarter. Total third-quarter retail cigarette market share for RAI’s operating companies increased 0.3 of a percentage point from the prior year quarter to 34.6%, with their combined drive brands adding 0.4 of a percentage point to 32.2%, and these drive brands currently make up 93% of our operating companies total cigarette market share.

At R.J. Reynolds third-quarter cigarette shipments fell by 2.5% from the prior year quarter, and after adjusting for wholesale inventory movements R.J. Reynolds’ third-quarter shipments declined by about 2.7%, and again that was versus the industry adjusted decline of about 3.4%. Total cigarette market share at R.J. Reynolds in the third quarter was in-line compared to the third quarter of last year at 32.3%. Newport, the nation’s number one menthol brand, continued to demonstrate outstanding momentum following its inclusion in R.J. Reynolds new retail contracts over the past year.

Newport’s volume in the third quarter was up about 1% versus the prior year and was not significantly impacted by wholesale inventory changes. We were also very pleased with Newport’s continued strength at retail as the brand increased its third-quarter retail market share by 0.4 of a percentage point from the prior year quarter to 13.9%. I would note that we continue to see Newport’s market share growth coming across all geographies and from both its core menthol style as well as its non-menthol styles. R.J. Reynolds Camel brand also continues to benefit from an improved national presence resulting from expanded retail contracts, offset by the impact from the removal of Camel styles associated with the FDA’s not substantially equivalent decision in the fourth quarter of last year.

As a result, Camel’s third-quarter retail cigarette market share was down 0.1 of a share point versus the prior year quarter at 8.3%. However, since the FDA decision last year, we have been very pleased that Camel has steadily grown market share from 8.1% to the 8.3% we saw in the third quarter, and R.J. Reynolds has exciting plans for the Camel Turkish family aimed at building the brand’s equity and growing Camel’s market share.

We will be providing more details in that regard at our upcoming investor day presentation in New York next month. Pall Mall, the nation’s number one value brand, continues to play an important role in the company's total portfolio strategy and we are very pleased by its increasing profitability and contribution to the bottom line. In the current environment with many adult smokers trading up into premium brands, Pall Mall’s third quarter retail market share was down 0.2 of a percentage point versus the prior year but was in-line with the second quarter of this year at 7.7%.

At Santa Fe, Natural American Spirit's distinctive premium brand, continues to outperform. In the third quarter, the brand increased retail market share to 2.3%, which is an increase of 0.3 of a percentage point from the prior year quarter, and looking forward we expect continued growth from Natural American Spirit as the brand benefits from increased consumer engagement and growing of awareness of the brand’s unique values.

At American Snuff, Grizzly Dark Mint, which combines the richer and bolder taste of its dark style with the popular mint flavor, was successfully expanded nationally late in the third quarter. The differentiated Dark Mint style has been very well received by consumers and should continue to benefit Grizzly going forward.

Grizzly’s retail market share of 30.7% in the third quarter was up 0.2 of a percentage point sequentially and declined by 0.4 of a percentage point compared to a very strong third quarter of last year.

Grizzly’s also continues to lead the growing pouch category, which now makes up more than 20% of the moist-snuff industry, and the brand is the clear leader in Wintergreen, which is the largest flavor category. We continue to be very confident in Grizzly’s strong underlying trends, its authentic product proposition, its highly loyal consumer base and its ability to deliver sustainable, profitable growth over both the near and long-term.

Before we move onto Andrew, I will give you a quick update on RAI innovations and its subsidiaries, which are working hard on their mission to redefine the vapor category. RJR Vapor, whose VUSE digital vapor cigarettes continue to grow volume and lead the category with market share more than three times its closest competitor in traditional retail channels will expand availability of VUSE VIBE next month.

VIBE, an exciting new format for the VUSE family of products, is a high-capacity, closed cartridge tank system with a rechargeable battery. VIBE offers more liquid than the brand's previous products and also has a more powerful and longer-lasting battery. So it meets the desires we have heard from adult tobacco consumers to combine the ease of use of a cigalike product with the performance of a tank system. In the third quarter, RAI Innovations invested significantly in a variety of vapor platforms, as well as in the regulatory support behind them, and you will hear more about the company's Innovations pipeline in the coming months.

Niconovum ZONNIC, nicotine replacement therapy gum, also continues to perform well. As you know, the brand rolled out a ten count mini lozenge in selected stores in the third quarter, and this style is now available in about 19,000 outlets. So that is a quick look at our operating companies’ achievements in the latest quarter and over the first nine months of the year. We started the year with a robust plan for growth and a focus on strengthening our premium portfolio of drive brands, and we are on plan against those objectives.

We also have exciting plans in place to further build upon this success and we are confident that our businesses will continue to deliver on our objectives for future growth. Now I'll turn the call over to Andrew.

Andrew Gilchrist

Thank you, Debra, and good morning everyone. Reynolds American had a very successful first nine months of the year with strong financial performance across each of its operating companies along with a successful completion of our integration process.

To start off, I will cover our financial results for the quarter and year-to-date period. RAI's third quarter reported EPS increased by 30.4% from the prior-year quarter to $0.60. As you know, this comparison includes the impact of the implementation and asset impairment cost last year. On an adjusted basis, third quarter EPS was $0.61, up 10.9% from the prior-year quarter, benefiting from higher net pricing in both cigarettes and smokeless. This adjusted EPS excludes a charge of $0.01 per share related to Engle progeny lawsuits.

For the first nine months, reported EPS was $3.65, up 49% from the prior-year period. Adjusted EPS over the first nine months was $1.69, which was up 12.7%. These nine month adjusted results also reflect charges of $0.03 per share related to Engle progeny lawsuits, as well as a gain of $2.11 per share related to the sale of Natural American Spirit's International business, and charges of $0.12 per share for debt and financing costs and implementation costs.

RAI's third quarter adjusted operating margin continued to expand, increasing 4.1 percentage points to 48.5%, demonstrating the enhanced strength and profitability of our companies’ businesses. That brought first nine months adjusted operating margin to 46.6%, up 4.9 percentage points from last year's first nine months.

Now, let's take a look at our operating companies' performance, where I'll discuss adjusted results where applicable. Please refer to Schedules 2 and 3 at the end of our earnings release for a detailed reconciliation of our reported to adjusted results.

R.J. Reynolds continued to perform extremely well in the third quarter, which reported operating income up by almost 16% at just over $1.3 billion. The company benefited from solid net price realization of 3.9% in the third quarter compared to the prior-year quarter. Please note that R.J. Reynolds’ calculated net pricing for the third quarter does include a negative year-over-year impact resulting from the completed Reciprocal Manufacturing Agreement with ITG Brands. Excluding the impact, R.J. Reynolds net pricing would have been over 5% for the quarter.

On an adjusted basis, the company's third quarter operating income increased by 8.7% from the prior-year quarter to $1.3 billion. This reflects a charge of $25 million for Engle progeny lawsuits and $3 million for implementation costs. For the first nine months, reported operating income was $3.6 billion, and that was up 48.6% from this time last year. Nine month adjusted operating income came in at $3.7 billion, a 37.5% increase from last year.

R.J. Reynolds also continued to strengthen its adjusted operating margin, which grew by 3.7 percentage points from the prior-year quarter to 50.4%, an all time high for the company. R.J. Reynolds strong margin improvement in the quarter was largely driven by the net pricing, the synergy realization related to the Lorillard transaction, and the company's continued focus on operating efficiencies and productivity improvement.

As we touched on previously, wholesale inventory levels impacted industry volume declines in the third quarter compared to the third quarter of last year. Wholesale inventories for the industry were approximately 8.1 billion units at the end of third quarter this year, representing an increase of more than 1.2 billion units during the quarter. This compares to industry inventories of 7.6 billion units at the end of the third quarter last year, which remained stable over the course of that quarter. This dynamic helped moderate the industry volume decline to only 1.6% for the third quarter, a number that would adjust down to 3.4% when factoring in the impact of the inventory changes.

At R.J. Reynolds, the inventories of approximately 2.3 billion at the end of third quarter remained relatively stable versus the third quarter of last year, as well as over each quarter since the completion of the Lorillard acquisition.

Now, moving on to Santa Fe, where another quarter of very strong performance was supported by higher pricing and volume growth of 15.7%. Santa Fe increased its third quarter operating income by 27.7% to $154 million, and that brought operating income for the first nine months to $410 million, up 21.6% over the first nine months of the prior-year. Strong net price realization of 5% in the third quarter drove the company’s operating margin up by 2.7 percentage points to 57.9% for the quarter.

American Snuff reported another good quarter with volume growth of over 2% and net pricing realization of more than 9%. The company's third quarter operating income of $134 million was up 10.9% from the prior-year quarter, and that resulted in operating income in the nine months of $405 million, which was up by 10% from the prior-year period. American Snuff's third quarter operating margin decreased slightly by 0.3 of a percentage point from the prior-year quarter to 57.2%.

So that wraps up the summary of our company's performance. Now, I'll provide a quick update on our long-term debt position. RAI ended the quarter with $1.9 billion in cash balances, which takes into account the repayment of the company’s $500 million bond that matured on August 4. This reduction in RAI's total outstanding debt, along with the continued growth in our businesses has now brought the company within the top end of its long-term target leverage range of 1.5 times to 2.5 times total debt to EBITDA. I would note here that given the relatively low interest rate outlook along with our improving interest coverage, the company remains comfortable operating at the higher end of this target leverage range.

As we discussed last quarter, RAI's board of directors approved an increase in our target dividend payout ratio back to 80% of adjusted net income. And our board also approved an increase in our quarterly cash dividend of 9.5% to $0.46 per share, which was paid on October 3rd. This quarter’s dividend increase follows the 16.7% increase announced in February, and is the third dividend increase since we have completed the Lorillard acquisition last June. The company also began to implement its recently announced $2 billion share repurchase program with repurchases of approximately $75 million of RAI common stock during the quarter. The program is scheduled to be completed by the end of 2018.

These actions clearly demonstrate the company’s commitment to returning tangible value to our shareholders, as well as the confidence that RAI's management and board have in our operating companies' business strategies and performance going forward. And we remain focused on finding opportunities to further enhance shareholder value in a consistent and disciplined manner.

Now that we've reached the nine month mark for the year, we're narrowing the range of RAI's 2016 adjusted EPS guidance by $0.02 to a new range of $2.27 to $2.33, which is up 14.6% to 17.7% over last year's adjusted EPS. So all in all we are pleased with how our businesses have performed in the quarter and over the first nine months. We are also happy to be meeting our growth objectives for the year, particularly given the increased investments in innovation, regulation and state political engagements. Thank you all.

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] Your first question comes from Vivien Azer with Cowen. Your line is open.

Vivien Azer

Hi, good morning.

Susan Cameron

Good morning.

Andrew Gilchrist

Good morning.

Vivien Azer

So Susan, Debra congratulations on your evolving roles, I just wanted to start off with a discussion on Newport, given the deceleration that we have seen in terms of the market share gains over the course of the quarter, can you talk a little bit about how you’re thinking about price gap management and promotional spending on the brand? Thanks.

Debra Crew

Hi Vivien, thank you very much it’s Debra. I think Newport, we still feel very, very pleased with how the brand is performing, I think when you think about Newport, think about the year versus just the quarter. We’re actually up year-to-date by sort of percentage point on share for the quarter it was still up four tenths and also I think one of the things that really pleases us is that the growth we’re seeing in both menthol and in non-menthol as well as across all geography so we’re still seeing that. Of course, we’re starting to lap the stronger performance that we had last year, so I think that the deceleration in growth I think that you’re seeing is really kind of a lap in of stronger performance of prior year as well. I think as far as price gap management pricing the question there, pricing within the quarter was in-line with where we’ve seen it, we did not add or takeaway any promotional spending it was about on kind of average of where we’ve been, so there hasn’t been any changes there on Newport.

Vivien Azer

Thank you very much, that’s helpful. Andrew, I had a question for you please on the non-operating items, I mean, clearly, the margin expansion on the profit growth was good and better than I was looking for on the EBIT line, but clearly a lot of moving pieces in terms of some of the spend you guys had around. Political engagement you called out, so how should we think about that for the remainder of the year please?

Andrew Gilchrist

Yes, I would say Vivien really the engagements on the state political process generally were third quarter, there will be some run-on effect obviously in October, but generally those were concentrated in third quarter. Regulatory on the other hand I think is something that will be with us ongoing. So, some of those expenses really started with the deeming regs as we got a clarity on some of that regulation, we’ve ramped up some spending on that to make sure that we’re complaint and that we’re continuing to drive innovation to our business, but we see that as something that probably will continue on certainly for the next year.

Vivien Azer

Terrific, thank you very much.

Andrew Gilchrist

Thank you.

Operator

Your next question comes from Matthew Grainger with Morgan Stanley, your line is open.

Matthew Grainger

Thanks, good morning and congratulations Susan and Debra as well. So, I guess first question to Andrew just on the guidance range which you narrowed but it still has a fair amount of flexibility around that $0.07, could you dispute to what you see some of the key variables that moved you to the lower, higher end of the range so within the fourth quarter?

Andrew Gilchrist

Well, thanks for the question Matt, I think obviously we noted down to 227 to 233 which as we stated is up 14.7% to 17.7%, so we continue to feel very good about that certainly midpoint of that range continues to be consistent with where we were at the beginning of the year and there is inherent variability in the business. So obviously with volumes we’ve seen a significant shift in volumes I think throughout the year it’s been relatively consistent with where we’ve been from our plan standpoint, we talked about 2% at the beginning of the year, I think right now best estimate between 2% and 2.5% that’s probably a good view but obviously we still have one quarter to go, will have to see how that plays out. But we also have other regulatory cause and we opted to see how this plays out for the remainder of the quarter. But all in all we’re very pleased with how the year has gone, we’re pleased with the 14.7% to 17.7% growth that we’ve laid out in terms of our guidance range and we’ve still got one quarter to go, but we feel good about where we are.

Matthew Grainger

Okay. So, it’s fair to say that it’s a combination of operating results and potential some of the regulatory dynamics that continue through the quarter that you mentioned earlier?

Andrew Gilchrist

I think that’s right and in particular volume obviously is a constant variable.

Matthew Grainger

Okay. And with the ITG reciprocal sort of drew up during the quarter one-off, will there be another one as you clear the rest of the inventory in Q4?

Andrew Gilchrist

Are you talking about the price realization, the comment that we made?

Matthew Grainger

Yes. Right, the pricing adjustment?

Andrew Gilchrist

So, the pricing adjustment will, there will be another pricing adjustment in the fourth quarter as that wound downs, but certainly that had the biggest impact it was in third quarter of this year, but we were, as Matt just to be clear, we did have income on that reciprocal manufacturing agreement for the entire time that we were making products for ITG, so when you go through the calculated net price realization that is something that we wanted to provide some color on because I think generally you want to get a sense of what other brands doing and that’s really why we wanted to come forward with little bit of that color because excluding that we would have been north of 5%.

Matthew Grainger

I agree, it’s definitely helpful of that disclosure. And just one last question on American Snuff, I wouldn’t ask about the pricing growth which was up 9% despite the fact that you are calling out in the release to continued level of competitive intensity, just curious how you are thinking about the balance between share growth and pricing at the moment and I realized that you had a difficult comparison to the prior year just the two factors?

Debra Crew

Matt, I think on American Snuff remembering that some of this is just simply timing. So we launched Grizzly targets of really the tail-end of this quarter. So certainly that was kind of full priced and that drove about some of that net price realizations really for third quarter. But most of the activity of course on Dark will come and the benefit on share will really come in the upcoming quarters.

Andrew Gilchrist

Matt, I just add I don't think there has been any change in philosophy on Grizzly at all. Our focus is to continue to grow that brand, continue to grow market share on that brand. We think we can do that in a very profitable way. We’ve got margins that are north of 55% and our focus is to continue to drive growth both in volume and market share.

Matthew Grainger

Okay, great, thanks everyone.

Operator

Your next question comes from Nik Modi. Your line is open.

Nik Modi

Congratulations. Quick question on the non-core Newport styles, maybe you will talk about this more in Analyst Day, but can you just provide some thoughts on kind of how you are thinking of strategically positioning those two brands? Have you had some time to kind of review their positioning etcetera?

Debra Crew

Sure. So Nik, as you said we will be talking more about this in the broader portfolio strategy on Newport at our upcoming Investor Day. And we can certainly provide a lot more color then. I think we talked about the styles of Newport both menthol and we are finding non-menthol also to be quite important to the franchise and it's certainly working in a different way in our portfolio from some of our other brands. We like the geographic development of some of the Newport non-menthol as well as the demographic of that adult tobacco consumer really works for us and it's quite complementary to the rest of the portfolio. So, we will talk a little bit. We have got the Newport smooth select that we talked about at our last Investor Day and some of the moves we are making on that to kind of make that little more relevant in the portfolio but certainly we can provide some more color on that in November.

Nik Modi

Great. And then, on the Camel brand obviously things have been improving sequentially. What’s really driving that? Is it primarily the menthol side or is there other core styles that are doing better?

Debra Crew

Yes, it is mostly the menthol that the Camel Crush is doing very well. But I will also say our Camel Classic style has stabilized as well. So, we’re feeling great about that. We talked about in this call the upcoming Turkish expansion that we plan on doing. And once again we can talk about the broader portfolio strategy on Camel in November as well, but I think really what’s driving the growth is the Crush style but also that stabilization of Classics.

Nik Modi

Great. That's it from me.

Operator

Your next question comes from Adam Spielman with Citi. Your line is open.

Adam Spielman

Thank you. I actually have two questions. The first is about the difference between the underlying volume growths of the industry which I think you said was down 3.4% [indiscernible] which is significantly less bad than that. And I was under the impression that NSAI data is actually little bit better to the data so I was wondering if you can talk about difference and why you think it occurs?

Andrew Gilchrist

Yes, Adam this is Andrew. I will give you, I think some perspective and I think this is important to understand as well. If you think about the 3.4% which is an inventory adjusted, it's essentially a calculated number with inventory adjustments in third quarter. We go back to second quarter we had an inventory adjusted number of 1.7% decline. Because of some of the calendar differences between last year and this year, the way I would really think about that is if you look at the two quarters combined they are roughly about 2.5% each and I think that's probably the best indicator on actually where the industry is. So obviously, we have some different periods with standard data and so on but NSAI I think is certainly real volume and certainly this is just a calculated number but from a general standpoint the 2.5 is how we are thinking about it and certainly that 2 to 2.5 range that we talked about for the full year is our expectation.

Adam Spielman

Okay. That's extremely helpful. Thank for you that. And my second question I had and it echoes a bit comment of Vivien made earlier. I was very surprised about how much margin expansion there was in RJRT in 3Q relative to the margin that you have achieved in 2Q. And I was wondering if you could just talk about what was really driving that and I guess if you can throw it forward as well that would help it. But really understanding why the margin expanded so much sequentially?

Andrew Gilchrist

Well, generally it's a mix driving that. We certainly have had strong net price realization including a price increase in second quarter that you saw. But generally, it's been driven by mix and that is obviously our fasted growing brand in RJRT and Newport. And that happens to be our highest margin product. So I think we are in very good shape on that front.

Adam Spielman

And does that imply future quarters we should see some sort of similar expansion? And I guess also the other question is, how was this affected we talked about the adjustment from the reciprocal manufacturing agreement coming off. My guess is did that had an impact on margin as well but it's obviously full technical and some explanation would be lovely?

Andrew Gilchrist

You are exactly right. But I would say obviously we are seeing four synergies here going forward as well. So third quarter was generally as we talked about we were working through the inventories. And we did that towards the end of third quarter. We got two inventories that are being manufactured by RJRT. So from a productivity standpoint, from a synergy standpoint all of that is certainly adding to our margin improvement and that's an incremental and certainly a sequentially sort of improvement that we see in the business.

Adam Spielman

Okay. Thank you.

Operator

Your next question comes from Christopher Growe with Stifel. Your line is open.

Christopher Growe

Hi, good morning.

Debra Crew

Hey Chris.

Christopher Growe

And congratulations Susan and Debra again. Thank you. I just wanted to ask a question a bit of a follow-on I think just indicated in interview that you did have four synergies in the quarter and I guess I was curious was there anything to the timing of synergies or we talk about some of the expenses that could be affected in the quarter that would have negatively affected RJRT's profits in the quarter, so anything on synergies or the timing of expenses?

Andrew Gilchrist

Yes, thanks for the question. Just so we’re clear on synergies, so full synergies will be in fourth quarter going forward. Third quarter we were still working down inventories that were manufactured at ITG. So the full run rate will be fourth quarter going forward. But obviously, we got there towards the end of third quarter. As far as the expenses, really a couple areas certainly regulatory compliance and our state political process engagements were too incremental cost that came through in third quarter and certainly we were concentrated in third quarter with some of the things that we were doing. So, if you look at that and certainly on a GAAP basis we had some additional cost on our angle. So that is also coming through an SG&A from a GAAP basis.

Christopher Growe

Okay and just to understand that for the fourth quarter were you expect a stronger rate of growth as the incremental synergies coming through and I guess the absence of some of these expenses that leads to the stronger fourth quarter profit expectation?

Andrew Gilchrist

The answer is yes. So, essentially some of those expenses will wind down and certainly we will have a full run rate on synergies as well.

Christopher Growe

Okay. And then just a question related to the all other division where you had a little bit of larger opportunity loss there. Not a big surprise given some of the activity in the quarter. I guess I want to understand we’ve asked this for several quarters now but just understand hopefully we win back closer towards kind of break even profitability that has pushed out a bit is it just the expenses related to some of the new products activity could that continue in the 4Q as well and keep that loss at a bit of higher level?

Andrew Gilchrist

Yes, I think certainly we continue to make very good progress on RJR vapor and that continues to move in the right direction. We are very pleased with that overall trajectory. But from a total all other standpoint we have had some slightly higher spend as we rolled out [indiscernible] we’ve had some slightly higher spend on our innovations. So some of those things are certainly coming through in offsetting but yes, we would expect to have some continued investment.

Christopher Growe

Okay. Thank you.

Operator

Your next question comes from Michael Lavery with CLSA. Your line is open.

Michael Lavery

Thank you and Debra and Susan congratulations to you both.

Debra Crew

Thank you.

Michael Lavery

Just was wondering if you could give some color a little more on the regulatory side. You have talked about some of the higher spending levels. Obviously there is some structural things that come with that. You called that with just needing to have headcount for some compliance thing but can you just talk a bit about where you stand on any PMTA or modified risk applications either for vapor or for eclipse?

Debra Crew

Yes, I think Michael we will talk more about this in November. We will give you a bit more of a longer view on some of our strategies within RAI innovations. But certainly the deeming kind of new coming out in May and then really the 90 days to get anything into the market certainly drove a lot of investment in this quarter and but going forward the PMTA cost are real and so we will have to be complying with that within the next couple of years. And when we do have plans to ensure that we can sustain our leadership position in this area it’s the key part of the strategy and we will make the necessary investments. But I think we do so and we’re prepared for it. We have got a great pipeline of innovation that we think is very relevant for the future and so like I said we will provide a lot more color on our kind of submissions and give you a little bit of flavor for what that process is but there is a significant cost to it certainly, but I think there is also lot of benefit.

Michael Lavery

And were you able to commercialize the products that you wanted to ahead of the August 8 deadline that presumably might distribute more broadly at later day?

Debra Crew

Yes. Absolutely and of course you are seeing the first one of those I’ve talked really briefly about [Slide] but we are very excited to be expanding that even further already this year. So that will be going out into the market starting in, it's already in the market a little bit but as far as really getting into really broad distribution in November.

Michael Lavery

And then, just looking further ahead I know you said you will elaborate more on the maybe just give us some glimpse of how you are thinking about [indiscernible] hasn't even gotten approval or even applied yet for its platform but if and when that comes how are you thinking about your approach either with the current eclipse product or next generation of it and what would you be doing to position yourself for potentially different competitive landscape?

Debra Crew

Yes, Michael I mean, and we have talked about this, we have got decades of experience in and [indiscernible] and we have learned a lot and we continue to learn more about that particular technology and I am going to differ a little bit to say we will talk more about that in November. Thanks.

Michael Lavery

Thank you very much.

Operator

Your next question comes from Bonnie Herzog with Wells Fargo. Your line is open.

Bonnie Herzog

Good morning and I too wish both of you and Debra congratulations on your new roles.

Susan Cameron

Thank you Bonnie.

Bonnie Herzog

My first question I was hoping you guys could provide a little further thoughts on the state of the tobacco consumer. It actually seen there could be some softening given raise in gas prices and then some uncertainty given higher taxes and raising health care cost, so curios if you would agree with that characterization and then how this maybe limiting up trading or the primitization trend that we have been seeing for so long?

Debra Crew

Yes, Bonnie I do think your characterization as far what I would say is we see it returning a little more to normal. That being said, it's still a very favorable macroeconomic environment. It's just we are laughing now. I mean it's been more than 18 months that we have seen very, very favorable and even improving trends I would say and now what I think you have is a little more stagnating trends. But there is still comparative historical, I mean, to be down on the year what we are projecting 2.5% is still very good relative to that historical norm of down 2% to 4%. We haven't really seen a change I would say in premium, in our premium growth in particular has been very strong. And so we are still seeing very strong trends on Newport, on Natural American Spirit. So I think within the combustible portfolio we are still seeing strong trends at the premium end, but we are certainly, you are seeing a little more activity in non-big three, you are seeing a little bit of activity certainly in some of the cheaper forms of tobacco again as well. So, but I think for relevant brands, relevant premium brands we are still seeing very strong growth there. So we still feel very pleased with the state of the consumer. But I think your characterization of, it’s returning a bit more back to the norms.

Bonnie Herzog

Okay that actually brings to my second question with some of your comments more on Pall Mall because it does seem that that brand has updating and increased amount of pressure so maybe you could drill down a little further on that and I guess I am getting the sense that as you mentioned too that the deep discount category has been picking up. So while premium might be staying quite strong you are also seeing the bottom end increasing I think. Is that possibly placing more pressure on Pall Mall or are you also facing pressure on Pall Mall comes from the other second tier brands?

Debra Crew

I think, so Pall Mall we talked about our portfolio strategy of really balancing the top-line and bottom line there. I will say for our portfolio currently we are leaning a bit more towards increasing the profit side of it because we are getting great growth at the premium end. And we are placing our investments and focuses at that premium end because we feel like that's the place to do it. That being said we do have, sequentially we have had several quarters of being relatively flat. We are just, it's in comparison to prior years where we are still seeing that pressure, but I think for now we are very happy and very pleased with where our portfolio is at and Pall Mall is playing its role.

Bonnie Herzog

Okay. And then final quick question is on your core [indiscernible] product that I believe tested in Japan. Do you have any update that you can provide us this morning?

Debra Crew

What I will say is we did complete our test of core in Japan, we were very pleased with the results. And we will talk more in November about [indiscernible] thank you.

Bonnie Herzog

Okay I appreciate it. Thank you.

Operator

[Operator Instructions] Your next question comes from Megan Cody with UBS, your line is open.

Megan Cody

Hi, thanks for taking my question. I was hoping to get some more color on what cigarette industry piping growth is running at if you drip out the mix impact of industry [premierization] and how do you expect that change going forward?

Andrew Gilchrist

Well, what we have seen over the past couple of years is sort of 5% to 7% for our business and I think that's right where we sit today as we said on an adjusted sort of adjustment basis here if you strip out the contract manufacturing we would have been in that range. So 5% to 7% sort of where it's been running and that's been very positive for us.

Megan Cody

And that's excluding the mixed impact of premierization?

Andrew Gilchrist

Yes.

Megan Cody

Okay. Thank you.

Operator

Okay, there are no further questions at this time. I will turn the call back over to Mr. Bannon.

Susan Cameron

Thank you. This is Susan everybody. I just wanted to take the opportunity as this will be my last earnings call as the CEO. I do look forward to seeing you all in New York, but I would like to comment on the headlines around the misses, I think it would be relevant to bring to your attention that the midpoint of our guidance range has not changed since February when we gave guidance. And that we are very, very pleased with our 15% to 18% growth and we are confident that we will deliver that. We are the only company really growing premium market share and I think it's important to look at this business on an annual basis and not get so worked up over these quarter to quarters. We are on our plan. We delivered double digital last year and we will do as we said 15% to 18% this year and we are very excited about this portfolio and our commitment to returning value to our shareholders. So I thank you all very much and I have enjoyed working with you and I will see you next month. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!