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Executives

Morris Moore

Daniel M. Delen - Chief Executive Officer, President and Director

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

Analysts

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Vivien Azer - Citigroup Inc, Research Division

Christopher Ferrara - BofA Merrill Lynch, Research Division

Margot Schacter - Jefferies & Company, Inc., Research Division

Andrew Kieley - Deutsche Bank AG, Research Division

Nik Modi - UBS Investment Bank, Research Division

Ann H. Gurkin - Davenport & Company, LLC, Research Division

David J. Adelman - Morgan Stanley, Research Division

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Reynolds American (RAI) Q2 2012 Earnings Call July 24, 2012 11:00 AM ET

Operator

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the Reynolds American Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, today's conference may be recorded.

And now, it's my pleasure to turn the floor over to Morris Moore, Head of Investor Relations. Please go ahead, sir.

Morris Moore

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

Joining me this morning are RAI's President and CEO, Dan Delen; and Tom Adams, our CFO.

The information we're about to discuss includes forward-looking statements. When we talk about future results or events, a number of factors could generate results 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're not required to publicly update or revise any forward-looking statements.

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

Daniel M. Delen

Good morning, everyone. I'm very pleased with the resilience that RAI and its operating companies demonstrated in the second quarter given the significant challenges they faced. As our results show today, our businesses remain sharply focused on balancing market share and profitability, and these efforts help drive RAI's earnings and margins higher in the quarter. Despite the ongoing and tense competitive promotional activity and the weak economy's drag on consumer buying power, R.J. Reynolds delivered solid performance on its key brands. And once again, the results were excellent at American Snuff and Santa Fe. Both companies continued to build outstanding momentum, and I'm pleased to report that all 3 operating companies delivered higher adjusted earnings and margins in the second quarter. And at RAI, we again delivered additional value to our shareholders with a dividend increase of 5.4% in May.

No doubt, the rest of the year will have its challenges, but with a solid first half now under our belt, we're confident about our ability to meet our objectives. And we're reaffirming our full year earnings outlook of mid- to high single-digits adjusted earnings growth.

So that's a quick look at our overall performance. Now before Tom and I talk about the second quarter, I'd like to update you briefly on some new product innovations our companies have been working on.

We've got some really exciting things in the works. For some years now, you watched us grow into a total tobacco company offering a broader range of products at different price points, in line with changing trends in the preferences of adult tobacco consumers and in societal expectations. Our operating companies have been leading industry innovation with the development of highly differentiated and successful products like Camel Crush and Camel SNUS. And we continue to work on refining and improving Camel's line of dissolvable products.

In line with our long-term strategy to transform the tobacco industry and reduce the harm caused by smoking, our companies have also been hard at work on developing a pipeline of new smokeless and other product innovation.

These products cover a broad spectrum, including heat-not-burn cigarettes, vapor, tobacco extract products and nicotine replacement therapy technologies. We believe there is significant growth potential in these new product formats, and we believe that our expertise and proprietary technology will give us a competitive edge.

For starters, RAI's Niconovum subsidiary has been exploring new markets and products in nicotine replacement therapy. Niconovum plans to enter its first U.S. market later this quarter, offering a new gum product under the Zonnic brand name for adult smokers who are interested in quitting.

So these are some areas in which our companies are developing new product innovation as they continue to position themselves for long-term growth. RAI's vision is to achieve market leadership by driving innovation throughout its businesses and redefining enjoyment for adult tobacco consumers.

For competitive reasons, we've been keeping some of our product innovation cards a bit close to our chest, but many investors and analysts have been asking what our plans are in the emerging tobacco products area. We wanted to assure you that not only do we intend to compete in this area, but we also believe the product development we have underway will truly deliver against adult tobacco consumer expectations.

Now let's take a look at our operating companies' performance. As I've already discussed, the quarter was marked by intense competitive activity, with promotions and discounting on value-priced line extensions on competitive premium brands. This impacted R.J. Reynolds' second quarter shipment volume, which declined 6.7% from the prior year quarter.

I would note that these declines were mainly on the company's non-focus value brands. This performance compares with an industry decline of 1.7%. However, when adjusted for wholesale inventory changes, the industry was down 2%.

Industry wholesale inventories were approximately 8.4 billion units at the end of the second quarter, down about 1.5 billion from the prior year quarter, while R.J. Reynolds' wholesale inventories of approximately 2.2 billion were down only 100 million units.

R.J. Reynolds' adjusted operating income increased slightly from the prior year quarter on higher pricing and productivity gains, as well as an improved premium mix. These factors also significantly benefited the company's adjusted operating margin, which jumped more than 2 percentage points to 33%.

Turning to market share. R.J. Reynolds' second quarter cigarette market share was 26.2%, down 1.4 percentage points. This decline was also driven by the non-focus value brands. R.J. Reynolds' growth brands, Camel and Pall Mall, delivered a combined market share of 16.7%. This was down a modest 0.2 of a percentage point from the prior year quarter.

Camel performed well despite the difficult market for premium-priced products and intense competitive promotional activity. The brand's second quarter market share declined slightly to 8.3%. However, Camel share of the true premium-priced segment jumped significantly in the quarter. Camel, which is celebrating its 99th birthday this year, continues to make substantial progress in the menthol cigarette category with the brand's menthol styles gaining 0.5 a percentage point of market share from the prior year quarter.

The use of R.J. Reynolds' innovative capsule technology and the recent expansion of Camel Crush Bold are strengthening the brand's position in the premium menthol category.

Camel's first smoke-free product, Camel SNUS, had another great quarter, now holds more than 75% of the growing snus category. Camel SNUS offers 6 styles in the recent expansion of its mint offering that further strengthens the brand's performance.

R.J. Reynolds continues to focus on building the brand equity of Camel SNUS as a convenient spit-free option for adult tobacco consumers.

As I mentioned earlier, Camel SNUS is an innovation that forms part of our transforming tobacco strategy, and I'm pleased with the way the market is responding.

Turning to Pall Mall. Pall Mall, which saw tremendous growth in recent years, has drawn intense competition from other value brands, as well as from value-priced line extensions of competitive premium brands that sell at or below Pall Mall's price. This impacted the brand's market share in the second quarter, and Pall Mall declined 0.2 of a percentage point. However, Pall Mall's performance strengthened as we moved through the quarter and competitive promotional levels moderated slightly.

R.J. Reynolds continues to focus on building Pall Mall while balancing the brand's share and profitability. Pall Mall has built its own brand equity as the brand that will always be there to provide a longer-lasting cigarette at an affordable price, day in and day out.

And R.J. Reynolds believes that equity and product differentiation will continue to resonate with adult tobacco consumers, especially in today's weak economy.

Turning to the moist-snuff business. I must say that American Snuff performed extremely well this quarter. It's also operating in a very competitive environment, and the company's key initiatives are really paying off. American Snuff delivered substantially higher operating income and margin, as the company's flagship brand, Grizzly, drove higher moist-snuff volume and pricing. American Snuff's second quarter shipment volume increased 10.7% from the prior year quarter, which was more than double the industry's growth rate. And American Snuff also increased its moist-snuff market share, which rose nearly 2 percentage points from the prior year quarter to more than 32%.

The Grizzly brand, which is at the core of this powerful performance, is benefiting from the brand's equity enhancements. The brand is also benefiting from the investment in retail contracts and expertise from the larger sales force at R.J. Reynolds, which serves American Snuff.

Grizzly increased second quarter shipment volume by over 12%, and the brand's market share increased by 2 percentage points to 29%. The brand saw outstanding growth in its pouch style, which captured 70% of all pouch style growth. The company's focus on Grizzly's natural style offers good growth potential, as the brand is underrepresented in these styles. Grizzly has recently introduced new packaging to better convey the premium quality and value of Grizzly's premium natural styles. And I'm happy to say that based on the performance of Grizzly naturals, their strategy is working.

So it's clear that American Snuff is making great progress, and I'm confident that the company's strategies are laying the groundwork for continued success.

Moving on to Santa Fe where results were, once again, impressive. The company reported an increase of over 25% in operating income in the second quarter, driven by volume growth of almost 10% on its super premium Natural American Spirit brand. And in market share, Natural American Spirit gained 0.2 of a percentage point from the prior quarter, to 1.1%. I'd remind you that this brand is undiscounted, yet has posted consistent volume and share growth every year since Santa Fe was founded in 1982.

Natural American Spirit continues to enhance its retail presence, and has built an extremely loyal franchise with its unique additive-free and organic tobacco offerings.

So to wrap up, RAI's operating companies again demonstrated their strength and resilience and are successfully managing through a challenging environment. They're also focused on building and strengthening their key platforms and innovations for long-term growth. And we're very excited about the new initiative on the horizon.

Now I'll turn the call over to Tom. Tom?

Thomas R. Adams

Thank you, Dan, and good morning, everyone. Reynolds American delivered solid results in the second quarter and first half despite the challenges, and we remain on track to deliver our adjusted EPS guidance of $2.91 to $3.01 for 2012. This excludes charges for the Engle progeny lawsuits and the restructuring. I will remind you that the workforce restructuring will generate savings of about $25 million this year, and those savings will increase to about $70 million a year in 2015.

Reynolds American's second quarter adjusted EPS was $0.79, up 11.3% from the prior year quarter. Adjusted results exclude the charge of $0.01 per share for the Engle progeny litigation. That brought the first half adjusted EPS to $1.41, up 4.4% from the prior year period. These adjusted results also exclude a charge of $0.16 per share for the restructuring and prior year charges for implementation costs and the Scott lawsuit, as well as a small gain for tax items.

On a reported basis, second quarter EPS was $0.78, up 39.3% from the prior year quarter. First half reported EPS was $1.24, up 2.5%. The company delivered strong growth and adjusted operating margin in the second quarter, gaining 2.4 percentage points from the prior year quarter to 34.2%.

Now turning to our operating companies. As I review the individual operating companies' performance, I'll focus on adjusted results to provide perspective on their underlying businesses.

Starting with R.J. Reynolds. The company's second quarter adjusted operating income increased slightly from the prior year quarter to $604 million, with higher pricing and productivity gains offsetting cigarette volume declines and increased promotional spending.

Adjusted results exclude a charge of $10 million related to the Engle progeny litigation. The pricing gains, together with the improvements in the company's premium mix and productivity led to an increase of 2.3 percentage points in adjusted operating margin, bringing it to 33%. For the first half of the year, R.J. Reynolds' adjusted operating income was just over $1.1 billion, in line with the prior year period.

First half adjusted results exclude the litigation charge I mentioned, as well as a restructuring charge of $138 million. Despite the highly competitive market, R.J. Reynolds kept the tight focus on balancing profitability and share, and this allowed it to report a solid increase in its first half adjusted operating margin, which was up 1.7 percentage points from the prior year period at 32.3%.

Turning to our moist-snuff business, which continues to show great momentum. American Snuff increased its second quarter operating income by 18.4% from the prior year quarter to $95 million, and the company's operating margin rose 3.2 percentage points to 55.4%. For the first half, adjusted operating income was up 6.8% from the prior year period at $179 million. This comparison reflects the impact of the sale of Lane last year and the investments in retail moist-snuff contracts.

American Snuff's first half operating margin was 54.3%, up 2 percentage points.

Now turning to Santa Fe. Volume and pricing gains drove Santa Fe's second quarter operating income, up by 25.9% from the prior year quarter to $64 million, and the company's second quarter operating margin increased to almost 50%. For the first half of 2012, Santa Fe's operating income was up 17% at $109 million, and the company's operating margin increased 1.5 percentage points to 47.5%.

So that wraps up our operating performance. Now I'd like to touch on some of Reynolds American's other financial highlights, which speak to our strong balance sheet and commitment to shareholders.

RAI ended the second quarter with cash balances of $1 billion, and that was after repaying $450 million in debt that matured in June. RAI continues to maintain modest debt levels and a conservative leverage ratio of 1.3x debt-to-EBITDA.

I would also note that our pension plan remains well funded, currently at about 90%. As part of RAI's $2.5 billion share repurchase program initiated late last year, the company repurchased 6.1 million shares for $250 million in the second quarter at an average cost of $41.12 per share. That brought our total repurchases to date to 19.2 million shares for a total of $788 million.

In conclusion, RAI remains committed to enhancing shareholder value, and one way we do that is through our attractive dividend. To that end, RAI increased its dividend by 5.4% in the second quarter to an annualized rate of $2.36 per share. RAI shares currently deliver a yield of over 5%.

While the rest of the year remains challenging, we're pleased with our results through the first half and we're confident of meeting our adjusted EPS guidance of $2.91 to $3.01.

Thank you. Now we'll turn to the Q&A portion of the call. Huey, will you remind our callers how to get in the queue?

Question-and-Answer Session

Operator

[Operator Instructions] Our first questioner in queue is Bonnie Herzog with Wells Fargo.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

I had a question on the -- your new non-combustible innovation that you talked about. It sounds like your strategy is to pursue these opportunities organically. I guess, I'm curious, would you consider acquisitions and/or partnership? And also, would you consider leveraging some of your existing brands for this technology? Or are you going to be developing new ones?

Daniel M. Delen

Bonnie, I think, first of all, I would describe our innovations effort as really being across multiple platforms so we continue to innovate within the cigarette category, but also within moist-snuff and then obviously moving on from there into snus, dissolvables, heat-not-burn as well, vapor and even nicotine products in the name of nicotine replacement therapies. And I think really within that, I think we have a good organic development program within our R&D. But of course, we also look externally, and I think all those options are open to us as we sit here today. And in terms of your thoughts about partnership, I think that is certainly something that has come to mind as we've navigated this environment and, particularly, on the international side, where we keep looking for opportunities to monetize some of our innovations internationally. I think from the branding side of things, I think those are things that we continue to think about, how we come to market. And I would say the answer is a little bit different depending on which platforms we're talking about.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Okay, Dan, that's helpful. And just a follow-on to that. I'm curious also, at retail, what you're noticing or hearing from the retailers in terms of space allocation as you're seeing a lot of these subcategories exploding, whether it be snus, dissolvables, smokeless and, of course, the e-cig. Are they allocating more space to some of these newer categories? And if so, is the cigarette category losing real estate? I'm just trying to understand some of the dynamics from your perspective at retail.

Daniel M. Delen

Yes, I would describe it this way, Bonnie. There, obviously, is a heightened sort of focus on this from -- in the retail environment. I think, if you look at the different categories today, some of the retailers have it placed sort of fragmented in different places in their stores where they might have moist-snuff in one area and then some of the other tobacco categories somewhere else in the store or behind the counter. And I think there's more and more of the retailers are sort of beginning to line it all up on the back bar and beginning to consolidate some of these categories. And I think it's -- some of the more progressive thinking I've seen out there is to actually create a home for all these alternative tobacco products that really includes all those categories that you mentioned. So we have not noticed any significant reduction in space allocation to combustibles or to the smokeless categories. So I think it's just an emerging kind of trend to put all these products together on the back bar.

Operator

Our next questioner in the queue is Vivien Azer with Citi.

Vivien Azer - Citigroup Inc, Research Division

My first question has to do with the margin expansion posted in the RJR T segment. Given how robust it was, can you give us a sense of the kind of the components of that price versus mix versus cost savings?

Daniel M. Delen

Yes, I think there's a number of different areas that came into play here, Vivien. I think, first of all, from a net price realization, and we calculate this x the contract manufacturer because that obviously has some -- its own year-on-year dynamics. But from a net price realization, we had 2.8% in the second quarter. And then also from a mix perspective, what you see is we saw Camel do relatively well relative to premium sales of our competitors. In fact, when we looked at Camel performance for the quarter and if we were to define it on really what consumers pay, so the true premium category, Camel's share of that segment was actually up 0.5 share point in the quarter. So there is a mix impact relative to our competitors that way as well. And then, of course, the rest is coming through from cost savings and good cost management throughout the company.

Vivien Azer - Citigroup Inc, Research Division

Understood. It's encouraging to hear that you said some of the market shares for your brands sort of improved over the course of the quarter after Marlboro Black rolled off their promo. But I'm curious what -- did you guys experience any disruption as Altria implemented the new Marlboro architecture at retail?

Daniel M. Delen

No. I mean, I would kind of describe the retail environment this way. There's continual sort of month-to-month, quarter-to-quarter kind of toing and froing in terms of space allocation at retail. I would say that it wasn't significant in terms of the impact on us. And when I look at the retail environment, I'm happy with the amount of space that we have, and that we have enough real estate at retail to be able to communicate our brands properly and display the brands, and frankly get the price communication and equity communication that we need to support our brands properly.

Operator

Next questioner in queue is Chris Ferrara with Bank of America.

Christopher Ferrara - BofA Merrill Lynch, Research Division

On the cigarette category overall, I mean, obviously, it's a heated competitive environment. I think, you guys have definitely talked about that. But I thought you said that Pall Mall started to improve at the end of the quarter and maybe competitive levels of spending started to ease up a little bit. Is that right, and can you elaborate a little bit?

Daniel M. Delen

Yes. What we really say is during the quarter, I think we -- it's fair to say that Pall Mall ended the quarter in a better place than it entered the quarter on, certainly from a market share point of view. And I think 2 things really happened that, I think, were significant during the quarter is one, obviously, there was a price increase that competition took that we took as well during the quarter. And secondly, the promotional environment, it did ease off. Now I think we need to characterize that. I would still characterize it, even at the end of the quarter, as being highly competitive, but it did reduce slightly in the month of May.

Christopher Ferrara - BofA Merrill Lynch, Research Division

And do you get the sense that, that's a sort of a sustainable easing or does it look more like a blip on the radar screen?

Daniel M. Delen

Well, I think time will obviously tell with that. And I think really when we start looking at the promotions out there, there's 2 things going on. There's regular discounting that happens on brands. Then, of course, there's sort of pre-priced promotions that go into the marketplace. And I think, I would describe it on both fronts as still being highly competitive, but it was on the regular discounting of some competitive brands that we saw slight easing in the month of May.

Christopher Ferrara - BofA Merrill Lynch, Research Division

Okay. That's helpful. And then just, I guess, trying to get a feel for how you're feeling about market share in general. I guess, the shares are falling, I guess, probably a little bit more than you might have anticipated given the level of competition, but the share losses notably are not coming from Camel and Pall Mall in any material way. So I guess, the question is, is there a greater tolerance to give up some share at the nongrowth brands? I guess, when do you get to a point where you need to react, or are you not thinking about it that way on those nongrowth brands?

Daniel M. Delen

Yes, the way I would describe it is at the end promotional dollars are investment dollars and the return on investment is a little bit different depending on what brand is in what category. Certainly for Camel and Pall Mall, there's a good long-term sort of sustainable return on that investment. When we look at the nongrowth brands, what you see is they have older -- on average, older consumer franchises, slightly more price-sensitive consumers. And so the investment decision that you make on those is slightly different. Now I do think it's fair to say that we, again, also saw some improvement in trend on those brands throughout the quarter, and we do selectively support in certain geographies to reduce levels, but we do selectively support some of those brands. So I'm actually happy with the profile of the company through the quarter, and that things were improving slightly on these nongrowth brands by the end of the quarter.

Operator

Next questioner in queue is Thilo Wrede with Jefferies.

Margot Schacter - Jefferies & Company, Inc., Research Division

This is Margot Schacter in for Thilo. Most of our questions are actually addressed already. But the press release talks about your conservative leverage on the balance sheet. And I was just wondering what would compel you guys to go from a more aggressive leverage target.

Thomas R. Adams

Well, I mean, part of it is, I mean, we will be looking to the markets to refinance some debt that's coming due next year, and so we're going to be looking at that as we move in to the second half of the year. And then, if there's other need for cash, that would also compel us to access the debt market. At this point, we actually have a pretty favorable rate on average. It's about 5.4%, and we've got, as I said, about $685 million that's coming due next year, and we'll be refinancing that at favorable rates.

Operator

Next questioner in queue is Andrew Kieley with Deutsche Bank.

Andrew Kieley - Deutsche Bank AG, Research Division

Dan, just going back to the broad sort of pricing and promotional environment, I guess, your commentary earlier, it sounds like sequentially a little bit better than things were in the first quarter, mostly on the -- in terms of competitor activity. Are you seeing any improvement in terms of the actual consumer activity and down trading within the categories? Has that gotten better at all in terms of going from premium to discount products?

Daniel M. Delen

Here's the way I would kind of describe it. I think there is still pressure that way from the consumer. But frankly, in my mind, I think we've kind of reached a point where I believe some of the down trading is actually going on. And of course, this is an area where reasonable minds can disagree, but I believe part of it now is also manufacturer-led, as there's a lot of price competition on the marketplace. There's a lot of promotions out there. And so it becomes pretty hard to discern what's driving what. Is it the consumer looking for lower-priced options or is it that there's still many low-priced options available and so much attention drawn to them out at retail that manufacturers are kind of aiding and abetting, if you want, in some of these down-trading trends. But I do think that we've reached a point where certainly, the growth rates at the bottom end of the market, for products that are lower-priced, seems to be moderating.

Andrew Kieley - Deutsche Bank AG, Research Division

Okay. And then just given how intense promotions remain, are you still happy with the positioning of Pall Mall? I mean, is there any thought to altering promotional strategy on that brand or EDLP contracts or any adjustment from that brand?

Daniel M. Delen

Yes. I think -- here's the way I would kind of describe Pall Mall. Pall Mall is really a fantastic brand. It's really built up its equity over time, and it's very strong in terms of the product differentiation it has out there with the longer-lasting cigarette, which makes it quite unique in the marketplace. And we continue to see a very high level of conversion from trial to basic adoption. Now what's really happened and what's changed in the marketplace is that because there's so many low-priced offers particularly from other premium brands in the marketplace, what we're actually seeing currently is the amount of new trialists out there for the brand has gone down significantly over time. And so really, I think the strategic imperative that we have as a company is to reinitiate some of that trial. And that doesn't mean that Pall Mall needs to be the lowest-priced option in every store every day, but it does mean that we need to roll out trial-generating activities. And that can be done in a number of different ways. And I'll give you an example of some of the more recent activities that are rolling out to retail as we speak. One is, for example, offering pre-priced promotions in limited quantities in select stores across the country. Why? Because it gets competitive activity and we just need to build up the level of trial, knowing that we're going to get 50% retention rate when that happens. The other sort of mechanisms that we've used is direct mail, and we've also used consumer engagement. So there's a number of different mechanisms that we're deploying and have been deploying over the last quarter to actually restimulate trial. And I think that strategy is working for us, and we see kind of the sequential kind of improvement throughout the quarter as we've deployed some of these new iterations of our strategy.

Andrew Kieley - Deutsche Bank AG, Research Division

Okay. And then last question for me was just in terms of the cigarette category outlook, just your thoughts with closing of the pipe tax loophole and the better state tax environment so far this year. Is that sort of positively changing how you're thinking about category growth on volume?

Daniel M. Delen

Yes. I mean, here's the way the kind of saw the entire category. I think for the quarter, and if we take a look, you obviously have the headline numbers in terms of cigarette industry, we believe it's down 1.7%. But when we adjust for wholesale inventories, and I just put the emphasis there on wholesale inventories only, the category was down about 2%. Now we continue to predict for the year that it's going to be down sort of in that 3% to 4% kind of range. But I think embedded within that number is the more benign taxation environment that you've talked about. Obviously, the big wild card out there on the SET front was the California ballot initiative, where we had a great run and a great result, which obviously makes that quite a positive impact to total category volume. So all in all, I think we're predicting that 3% to 4% kind of range for this year.

Operator

Next questioner in queue is Nik Modi with UBS.

Nik Modi - UBS Investment Bank, Research Division

So just 2 quick questions. One is if you look at the underlying consumption declines of the cigarette category, it seems to actually have been moderating over the past few quarters. I'm just curious on your views on that. And the second question is, is there any update on this whole Star Scientific patent dispute? I know it's gone kind of back and forth. I'm just curious where we stand on that particular topic.

Daniel M. Delen

Yes, I think first of all, on the -- if I just cover off the Star side of things. I think, really, what's happening there is if you take a look at the original kind of trials that actually happened there is we frankly got a good result. We were found to not be in infringement of the patents, although the patents were actually upheld, and that's actually what we're appealing is whether those patents are actually valid. There is a process of mediation going through, but we're vigorously defending our rights on that front. So I don't think there's any new news on that front, but we're very happy and very confident in our legal position. And, Nik, could you remind me what the first part of your question was?

Nik Modi - UBS Investment Bank, Research Division

The first one is just on the cigarette decline rate has been moderating. Any views on that, kind of what you think is driving that?

Daniel M. Delen

Yes. I think really what we see is a relatively benign taxation environment, which obviously has had an impact. We see sort of no change in the historical price sensitivity of demand across the category. And then, I think the thing that we'll be keeping a keen eye on over the coming months is actually what's happening with the whole roll-your-own, pipe-your-own kind of category. We are getting reports at retail of some of these stores actually closing down or closing down that part of their operation. I'm not quite sure yet, and we're not seeing back in the numbers yet exactly where those consumers might move. They are, obviously, very price-sensitive smokers, but very hopeful that they'll come back into the manufactured cigarette category.

Operator

Next questioner in queue is Ann Gurkin with Davenport.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Dan, I was wondering if you could help me understand. I continue to see share loss for you, and I know you're working on the portfolio mix and eliminating underperforming lines. But can you help me kind of as to where this goes or where we should maybe see an inflection point in terms of share performance?

Daniel M. Delen

Yes, I think the way I would describe it is this way, Ann. Is I think first of all, if I take the growth portfolio, I look at Camel. I think it's fundamentally healthy. We have a fantastic portfolio in Camel. It's got fundamentally strong and strengthening consumer demographic. A lot of that is driven by innovation. The capsule part of the Camel brand and those of the menthol styles and the switch in both product is actually up 0.5 share point year-on-year. And of course, we defined that category as being -- sort of that it competes against us, being the true premium segment. And really, we carve out the premium value segment, so lower-priced line extensions of other premium brands. And when we look at it that way, we see Camel actually growing within that category, also up 0.5 share point when measured that way. I think Pall Mall, I've addressed in my earlier comment, but again, it's fundamentally a well-positioned brand with product differentiation on it. Then when we take a look at the sort of collective nongrowth brands out there, I think we see some sequential improvement in Winston's performance. It's being supported selectively in select geographies. And I think, really, the brand that I would focus on within that category that's having a particularly difficult time in today's pricing environment is actually Doral, which is a value brand out in the marketplace with very price-sensitive consumers. A lot of that volume earlier on went to Pall Mall and currently, has a fair amount of interaction with some of these premium value line extensions on competition. So I'm actually feeling quite confident across the portfolio that we will continue to see improvement in trend as we move forward.

Thomas R. Adams

And, Ann, what I would add to that is that as we look -- I mean, we do provide, as Dan said, some pricing support on these nongrowth brands. But within that -- within those nongrowth brands, we look at them as the premium brands and also as value brands. And clearly, because of the price points and the margins that are involved there, that drives some of our pricing decision as to how much to put on those individual brands and therefore, may drive performance or lack thereof.

Operator

Next questioner in queue is David Adelman with Morgan Stanley.

David J. Adelman - Morgan Stanley, Research Division

Dan, I'm curious. Do you agree with the characterization that your response to higher competitive activity to date has been fairly restrained?

Daniel M. Delen

Yes. I would say that it's been more restrained than the aggressiveness that we've seen from some of our competitors.

David J. Adelman - Morgan Stanley, Research Division

Right. And what would cause you to become more forceful?

Daniel M. Delen

Well, I think really we look at the marketplace and we're trying to balance our profitability and market share performance. And of course, we look at our investment decisions from our optic and from our point of view. I think we have the right strategies in place to really generate a sustainable long-term growth, and balance out all the factors sort of impacting our business. So I'm confident in our sort of current stance in the marketplace. And we're just not looking just to buy market share. It's really about finding the right balance in our business going forward.

David J. Adelman - Morgan Stanley, Research Division

Okay. And then in the RJR Tobacco business during the quarter in terms of the cost, it looks like the controllable cost per pack might have been down 9% or 10%. And I'm just curious, were there any timing dynamics that flattered the cost structure this quarter? Or is that a sustainable normalized cost base?

Daniel M. Delen

David, let me just answer the question this way. There's nothing that comes to mind during the quarter that was particularly out of line from what we would expect to see in a normal quarter.

David J. Adelman - Morgan Stanley, Research Division

Okay. And then one last question, Dan, on the smokeless business, and it has to do with the pricing you implemented, I guess, 1 month or 6 weeks ago. Over the last several years, you took $0.10 a can on Grizzly, and you took $0.10 a can -- if competition wasn't raising price, you took $0.10 a can, some years your competition was reducing prices. This year, competition went up $0.05 and you only went up $0.05. And I'm just curious, why do you keep up the prior cadence in light of the continued strong marketplace performance of the brand?

Daniel M. Delen

Yes, I think, David it's an excellent question. I think, really, you need to look at pricing over the long term in terms of what we're actually able to generate. Don't forget that what's actually changed over the last couple of years is that there are now, similar to cigarettes but also in moist-snuff now, we see value-priced line extensions of what were historically premium brands. And so, obviously, we look at the competitive dynamics. We measure relative price-sensitivity demand of the brand. And I think, really, if we take a look at what we've been able to achieve on that side of the business, both from a margin growth point of view, which is very substantial in the second quarter, we had slightly over 55% operating margins at American Snuff company, which, year-over-year, is up almost 3 points. So I'm very happy with kind of the evolution of the operating income growth, the operating margin, the adjusted operating margin growth. And I think relative to competition, that business is doing extremely well both from a volumetric point of view, but also from a financial point of view.

Operator

Next questioner in queue is Judy Hong with Goldman Sachs.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Few clarifying questions. So, Dan, just in terms of the industry decline, so in 2Q, you said category was down 2% if you adjust for the wholesale inventory movement. Are you looking for the industry to be still down 3% to 4% for the full year?

Daniel M. Delen

Yes.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Okay. So I'm just wondering just given some of the positive dynamics we've talked about with the taxes and so forth, why not a better consumption decline expectation for the full year at this point in the year?

Daniel M. Delen

Yes, Judy. I think it's -- I mean, we'll, obviously, need to see what the future brings, and obviously reasonable minds can disagree in terms of longer-term estimates. But I do think we have some smaller excise increases flowing through. There was some industry pricing that happened more recently. And of course, what we're not factoring into our estimate at this stage is to see -- because we don't know what the full impact is going to be yet, any impact we might see from the recent legislation, federal legislation passed on the pipe-your-own category. So these were the actual machines sitting at retail where consumers can roll their own cigarettes. So I think time will tell. But I think that 3% to 4% kind of estimate is a reasonable estimate at this juncture.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

But that would still imply the back half decline of, like, 4% or 5%, just given the year-to-date performance for the industry as a whole.

Daniel M. Delen

Yes. Potentially, Judy, as I said, I think time will tell on this front as these different factors begin to get applied to the category.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Okay. And then I'm just following up on Camel. So just in terms of the non-menthol performance, and I recognize that you've done really well with the menthol side of that brand. But just in terms of the non-menthol, can you just help us understand kind of what's going on there both from a competitive perspective and then any other initiatives that you might have in place to improve that brand? Or are you just really looking at the Camel holistically, including menthol, and the modest share loss at this point in 2Q is still encouraging in light of what you saw competitively?

Daniel M. Delen

Yes. I think we look at the brand holistically, obviously, because there are some consumers that prefer menthol and some that don't. But I think -- and you're right on sort of the -- your observation about Camel Capsule is doing extremely well in the marketplace. I think the other thing maybe to think about from a brand dynamic point of view is the demographics of the brand, and particularly ASU30, the adult smoker under 30, which is increasingly, in that segment, that demographic, increasingly looking for menthol or mentholated cigarettes. And so when we take a look -- and Camel does very well amongst that segment. And as more and more of those opt for menthol cigarettes, I think Camel is very well positioned particularly with its Capsule innovations. So I would look at it sort of from that point of view, holistically, doing well and particularly doing well amongst that younger adult demographic where, increasingly, those consumers are opting for menthol.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Okay. And then lastly, sort of following up on the cost question. So SG&A in the quarter was down, I think, 10% or so. I'm just wondering, just in terms of the run rate, so if you look at just year-over-year, down about $38 million or so year-over-year. And sort of on an absolute basis, is there any kind of variabilities in the out quarters where that could affect the SG&A expenses? Because it seems like that's a pretty reasonable run rate to use, at least for the second quarter for the balance of the year.

Thomas R. Adams

Judy, are you looking at the -- our financial statements in Schedule 1? If you're comparing the $325 million to the $488 million...

Judy E. Hong - Goldman Sachs Group Inc., Research Division

No. I'm adjusting last year's numbers. I'm looking at $320 million versus, like, $358 million.

Thomas R. Adams

Okay.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Yes. So I mean, it's still kind of a meaningful decline, I understand. I know you have obviously some cost savings in place. So I'm just wondering, how much of maybe some of those cost savings were realized in the quarter and is there more to go the balance of the year? Or is this sort of $320 million kind of a good run rate for the balance of the year?

Thomas R. Adams

It's probably going to come down a bit from that. Our cost savings, as you know, from the business review, we concluded that towards the end of the first quarter. And so we saw a very modest amount of cost savings that flowed through this quarter, and we would expect the vast majority of that $25 million to occur in the back half of the year. Additionally, we saw our litigation expense that you'll see when we publish our Q in the next day or so, has come down by about $10 million quarter-over-quarter as we've been more efficient in the defense of our smoking and health litigation. And then, there's just a bunch of smaller items that are in there. So there isn't any one big item to point to. Just effective cost management.

Operator

[Operator Instructions] Next questioner in queue is Vivien Azer with Citi.

Vivien Azer - Citigroup Inc, Research Division

I had a quick question about the Niconovum gum products that you're launching in the U.S. Can you speak a little bit to kind of the scope or the scale of the distribution? Is it going national? What are the price points look like relative to competitive products, and what's the margin structure on a product like that?

Daniel M. Delen

Yes. I think -- let me describe a little bit what the effort is going to be is. We're actually planning to run a lead market in Des Moines, Iowa. And I think what we're looking at is to bring it from a pricing point of view, roughly in line with premium price cigarettes on a unit equivalent. I think really, we're trying to get some good consumer learnings out there as we enter this category for the first time here in the U.S., and obviously, trying to apply a lot of the expertise and learning that Niconovum has acquired over the years in Scandinavia. So I think, it's an exciting effort on our part to actually apply a lot of our or Niconovum's thinking to a different geography at this stage.

Operator

Next questioner in queue is Michael Avery [ph] with CLSA.

Unknown Analyst

I was wondering if you could just give a little more color on some of the innovation you described where you could -- I realize there's details you don't want to divulge, but could you give us a sense of some of -- what the timing might be on a few of those? I mean, obviously, there's some things on process, but you mentioned vapors, like if there's e-cigarettes -- is that something that might happen this year or further off? A little bit context for that.

Daniel M. Delen

Yes, I think maybe without getting into too much detail, Michael, I think really what I was trying to allude to is that over the next 6 months, really over the next couple of quarters is you'll start seeing some initiatives from us on all the fronts. And what I really mean by that is that we have a comprehensive R&D program in place, sort of addressing needs in all of these segments. And I think you mentioned vapor, I'll give you some insights into our thinking on that front. But when we look at the vapor category today, I think there's a fair amount of consumer interest in products like that. But what we see is very high levels of trial and relatively low levels of conversion and -- which, to us, indicates that, that's really the -- adequate products out there to meet that kind of consumer interest in that category, have not actually been deployed in the category yet. So that's really where a lot of our focus and efforts are our focused.

Unknown Analyst

That's helpful. And then, I think, I caught all the color on some of the category normalization, just trade shifts and things. But I might have missed, what was -- in this second quarter, what was the impact of your -- on your volumes from loading? Did you see a buy ahead that inflated -- that helped the volumes at all?

Daniel M. Delen

I think the way to kind of look at the category is this wholesale sort of inventory loading and deloading is an industry dynamic. I think it's fair to characterize our sort of efforts related to that as being much more moderated than the rest of the category. We have a long-standing kind of policy to try to not participate in these loading dynamics or -- and then, of course, you don't get the payback in terms of unloading either. And we do that by placing a lot of our wholesalers on allocation, so that there's less of an ability than some of our competitors to actually load and therefore de-load inventory.

Unknown Analyst

Okay, that's helpful. And then lastly on natural snuff, you say how the new products are sort of in line with your expectations. Can you give us a sense of what some of you were expecting? Are those off to a great start? Is it something you think will move slowly, but that it's coming along? Or how should we think about that?

Daniel M. Delen

I think a couple of dynamics out there on the natural styles. I think, first of all, if you take a look at it, they tend to be bigger or overrepresented in certain geographies.And I think it's also a product sort of subcategory where Grizzly historically has underperformed. So I think in -- from both points of view, it's kind of white space or relative space, where we can do better competitively. So we have actually targeted those categories in those geographies, and very happy to report that the results have been very good on that front, where those particular styles are growing in the intended geographies. And so I think, that really talks to the broadening of the Grizzly franchise. And it really is becoming a true national brand across all product categories, which is exciting to see. It already is the market-leading brand. But of course, even within that, it has opportunities for continued growth.

Operator

And there appears to be no additional questioners on the phone queue. I'd now like to turn the program back over to Morris Moore for any additional or closing remarks.

Morris Moore

Thank you, again, for joining us today. If you have any follow-up questions, please feel free to contact us at Investor Relations.

Operator

Thank you, sir. Again, ladies and gentlemen, this does conclude today's program. Thank you for your participation, and have a wonderful day. Attendees, you may now disconnect.

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