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Reynolds American (NYSE:RAI)

Q3 2012 Earnings Call

October 23, 2012 9:00 am ET

Executives

Morris Moore

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

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

Analysts

Vivien Azer - Citigroup Inc, Research Division

David J. Adelman - Morgan Stanley, Research Division

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

Michael Lavery

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

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

Priya Ohri-Gupta - Barclays Capital, Research Division

Andrew Kieley - Deutsche Bank AG, Research Division

Karen Lamark

Thilo Wrede - Jefferies & Company, Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Reynolds American Third Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. Now I'll turn the conference over to your host, Morris Moore, Vice President of Investor Relations. Please begin.

Morris Moore

Good morning, and thank you for joining our call. Today, we'll discuss Reynolds American's third quarter and 9 months results, as well as our outlook for the balance of the year. As always, our discussion today 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 available on our website at reynoldsamerican.com.

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

The information we're about to discuss includes forward-looking statements. When we talk about future results or events, a number of factors could generate results 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. As the results show today, Reynolds American's operating companies made substantial progress in the third quarter, allowing RAI to increase both earnings and margins. Despite significant economic and competitive headwinds, RAI's operating companies continue to build the equity of their key brands, while also investing in new smokeless and other innovations for long-term growth in the changing marketplace.

RAI's performance over the first 9 months has been solid, and we're reaffirming our full year guidance of adjusted earnings growth in the mid- to high-single digits. RAI and its operating companies continue to build momentum in their strategy to transform the tobacco industry. For us, that means operating our companies in a responsible, sustainable manner while continuing to deliver commercial success.

RAI's operating companies are achieving transformation of the tobacco industry as leaders in innovation. I'm pleased to report that RAI's Niconovum subsidiary has entered the market of Des Moines, Iowa with its first U.S. nicotine replacement therapy product under the Zonnic brand name. Meanwhile, another subsidiary, R.J. Reynolds Vapor Company, has introduced its first e-cigarette under the Vuse brand name in a limited number of stores.

As you can understand, it's early days for these new products, but we're excited about their potential for growth. We'll be talking more about these developments at our Investor Day presentation next month, which will be available by webcast.

Also during the quarter, RAI and its companies further strengthened their corporate sustainability efforts, and for the fifth year running, has awarded membership in the Dow Jones Sustainability North America Index, which provides independent recognition of RAI's commitment to sustainability.

In addition, R.J. Reynolds recently made major enhancements to its successful youth tobacco prevention program called Right Decisions Right Now, giving educators, parents and community groups easy online access to free educational materials. Youth tobacco prevention is a big part of our transforming tobacco strategy, and our objective is to accelerate the decline in youth tobacco use by continuing to work for further reductions in both access to and demand for tobacco products.

Now I'll discuss our third quarter performance in more detail. At R.J. Reynolds, adjusted operating income was down on declines in cigarette volume and higher promotional spending. However, higher pricing and productivity gains allowed the company to substantially improve its adjusted operating margin, which was more than 34% in the quarter.

Once again, R.J. Reynolds' results were affected by the aggressive competitive promotional activity in the marketplace. The company's non-focus value brands continue to be disproportionately affected by this activity. I would also note that there was 1 less shipping day in this year's third quarter. As a result, R.J. Reynolds' third quarter shipment volume declined 6.9%. This compares with an industry decline of 2.7%. Industry wholesale inventories were approximately 7.7 billion units at the end of the third quarter, down about 400 million from the prior year quarter, while R. J. Reynolds' wholesale inventories of approximately 2 billion were in line with the prior year quarter.

This tough competitive environment also affected the company's overall market share. R.J. Reynolds' third quarter cigarette market share was 26.4%, down 1 percentage point from the prior year quarter. Again, this decline was driven by R.J. Reynolds' non-focus value brands.

I'm pleased to note that the company's growth brands saw improved performance as they moved through the third quarter. Camel and Pall Mall posted a combined market share that was in line with the prior year quarter at 17.2%, and both brands delivered sequential share growth from the second quarter of this year. R.J. Reynolds remains focused on balancing profitability and market share on these brands while building their equity for growth over the long term.

Camel's third quarter market share was stable at 8.5% despite the [ph] promotional environment, as well as the ongoing economic pressure on premium-priced products. In addition, Camel share of the true premium price segment further increased during the quarter.

Camel's premium menthol styles, which offer relevant product differentiation with the innovative capsule technology, continue to support the brand's performance. These styles gave 0.4 percentage points in the third quarter, and they now hold a market share of 3%.

Camel SNUS continued to show strong momentum during the quarter and now holds about 80% of the U.S. SNUS category. With the expansion of Camel SNUS Mint earlier this year, attracting even more interest, it's clear that the smoke-free and spit-free convenience of Camel SNUS is appealing to adult tobacco consumers.

Turning to R.J. Reynolds' other growth brand. Pall Mall gained traction in the third quarter despite the significant competition from other value brands, as well as the growing segment of what I would call value-priced line extensions of competitive premium brands. Pall Mall increased its market share by 0.1 percentage points to 8.7% from the prior year quarter and also saw good sequential growth. Pall Mall benefited from the brand's targeted approach to gaining additional trial.

Pall Mall continues to enjoy a high rate of conversion as half the consumers who try the brand tend to stick with it. And now Pall Mall will be giving them 2 more reasons to do so. Pall Mall is enhancing its position in the menthol category with the addition of 2 new styles. Pall Mall Black, a full-flavor tobacco blend; and Pall Mall White, a smoother blend, are now available in addition to Pall Mall Green, the brand's existing menthol offering. Pall Mall is underrepresented in the menthol category, and the company expects this portfolio expansion to offer a good opportunity for additional growth.

Moving on to the moist-snuff business. American Snuff again delivered excellent growth across a broad front in the third quarter, reporting substantially higher adjusted operating income and operating margin. This was in large part due to another powerful performance by the company's flagship Grizzly brand.

American Snuff's third quarter shipment volume increased 6.6% from the prior year quarter, again outpacing the industry's growth rate of about 5%. In addition, American Snuff moist-snuff market share rose almost 1 percentage point from the prior year quarter to just over 32%. As the nation's best-selling moist-snuff brand, Grizzly increased third quarter shipment volume by 7.8%. And Grizzly's market share increased by more than 1 percentage point to 28.8%.

Grizzly is benefiting from activities to build the brand's equity like the Tellin' It Like It Is promotional campaign, which aligns the brand with its consumers in a very relevant and humorous way. Grizzly continues to make progress in the growing pouch category, and the brand now holds over 30% of total pouch sales. In the natural segment, Grizzly remains focused on strengthening its 5 Premium Natural styles, with new packaging upgrades that better convey the premium quality and value of these styles. Grizzly is underrepresented in this segment, and American Snuff believes this enhancement offers potential for additional growth.

Now turning to Santa Fe. The company continues to show excellent momentum in the third quarter, driven by great results from its super-premium Natural American Spirit brand. Santa Fe reported an increase of more than 35% in operating income, and its operating margin rose to more than 50%. And in market share, Natural American Spirit gained 0.2 percentage points from the prior year quarter to 1.2% on volume growth of 13.9%. It's clear that Santa Fe is doing an outstanding job in managing Natural American Spirit's success. It's a terrific consumer brand with a unique heritage and a highly differentiated product.

So to wrap up operating performance. R.J. Reynolds, American Snuff and Santa Fe are using effective strategies to successfully navigate the challenging environment, and innovation for future growth remains a key focus. In line with our transforming tobacco strategy, our companies are also meeting the changing preferences of adult tobacco consumers. I'm pleased that with 3 quarters of the year behind us, we're still looking at delivering on our commitment of earnings growth.

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

Thomas R. Adams

Thank you, Dan, and good morning, everyone. Thanks to the achievements of our operating companies, Reynolds American increased both earnings and margin in the third quarter, and this rounds out a solid first 9 months of the year. Based on this performance, I'm pleased to reaffirm that we're on target to meet our growth projections for the full year with adjusted EPS guidance of $2.91 to $3.01. This excludes charges for the 2012 post-retirement mark-to-market adjustments, Engle progeny and other tobacco-related litigation and restructuring.

Reynolds American's third quarter adjusted EPS was $0.79, up 6.8% from the prior year quarter. Adjusted results exclude the charge of $0.04 per share related to the post-retirement mark-to-market adjustments. The adjustments resulted from a design change for retiree medical plans that required a remeasurement of plan obligations. The adjusted results also exclude a charge of $0.01 per share for other tobacco-related litigation.

On a reported basis, third quarter EPS was $0.74 per share, up 10.4%. For the first 9 months, adjusted EPS was $2.21, up 5.7% from the prior year period. These adjusted results also exclude the 2 charges I've just mentioned, as well as charges of $0.02 per share for the Engle progeny lawsuits and $0.16 per share for the restructuring.

On a reported basis, 9 months EPS was $1.98, up 5.3% from the prior year period. RAI again delivered strong growth in adjusted operating margin, which gained 2 percentage points in the third quarter to 36.1%. That brought the company's 9-month adjusted margin to 34.4%.

Now I'll turn to our operating companies' performance, where I'll focus on adjusted results to provide perspective on their underlying businesses. First, at R.J. Reynolds, the company's third quarter adjusted operating income was $606 million, down 3.9% from the prior year quarter as cigarette volume decline and increased promotional spending more than offset higher pricing and productivity gains. However, the higher pricing and productivity gains helped the company's third quarter adjusted operating margin, which increased 0.7 percentage point to 34.2%.

For the first 9 months of the year, R.J. Reynolds' adjusted operating income was $1.73 billion, down 1.4% from the prior year period. R.J. Reynolds kept a tight focus on balancing profitability and share, and this resulted in a 1.4 percentage point increase in its 9-month adjusted operating margin to 33%.

And at our moist-snuff business, American Snuff generated strong third quarter adjusted operating income growth of 11.4% from the prior year quarter to $100 million. And the company's third quarter adjusted operating margin jumped 2.4 percentage points to 57.4% on the strength of moist-snuff volume and pricing gains.

For the first 9 months, adjusted operating income was up 8.4% from the prior year period at $279 million. American Snuff's 9-month adjusted operating margin was 55.4%, up 2.2 percentage points.

Now turning to Santa Fe. Natural American Spirit's volume, pricing and share gains drove Santa Fe's third quarter operating income up by 35.3% from the prior year quarter to $63 million. And the company's third quarter operating margin increased to more than 50%. For the first 9 months of 2012, Santa Fe's operating income was up 23.1% at $172 million. That brought the company's 9-month operating margin to 48.6%.

So that's a quick look at our operating performance. Now I'll cover some of Reynolds American's other financial highlights. RAI continued to make progress with its share repurchase program, repurchasing 6.5 million shares for $300 million in the third quarter. To date, the company has repurchased 25.7 million shares under the plan for a total of $1.1 billion.

During the quarter, RAI also contributed $50 million to its pension plan, which remained well-funded at about 90%. And the company ended the quarter with cash balances of $1.2 billion after repaying $100 million of the term loan.

So in conclusion, RAI continues to demonstrate a deep commitment to returning value to shareholders. The rest of the year remains challenging, but RAI's operating companies are well-positioned to deliver against their goals.

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

Question-and-Answer Session

Operator

[Operator Instructions] We have a question from Vivien Azer of Citigroup.

Vivien Azer - Citigroup Inc, Research Division

My first question has to do with your comment about the improving trends for your growth brands through the quarter, and whether you could speak to kind of the impact of promo versus whether that was in part driven also by an easing of the competitive landscape on a relative basis.

Daniel M. Delen

Yes, Vivien, if I kind of look at the quarter, I would say it's characterized probably by a little bit of both. I think -- we refer, obviously -- in the earlier section of this call, we referred to the intensely competitive environment. But I do think it's fair to characterize it as having eased very slightly from the beginning of the quarter to the end of the quarter. And what we saw is rates basically backing off a little bit in the market, and these are competitive rates on competitive brands. Having said that, there's obviously more volume in this new segment that we've kind of put the moniker of premium value on. And there's more volume down there, so I would say there's a little bit less per-pack promotion out there but across a larger number of packs, so the total financial weight in the market, if you want, was relatively similar. But given that it was a little bit less per pack, I would say the environment has eased back a little bit. And given that environment, I'm very happy with the way that both Camel and Pall Mall performed during the quarter. We see sequential change of 0.2 market share points, so a 1/5 of a market share point on each of those brands during the quarter.

Vivien Azer - Citigroup Inc, Research Division

Understood. Given how intense the competitive landscape has been for a while, have you guys taken a closer look at the near-term price elasticities and benchmarked it to kind of the historical price elasticities we've seen from the category?

Daniel M. Delen

We have actually, Vivien, and it's our belief that the overall category price sensitivity of demand has not changed. So when we look at the entire elasticity of the entire category -- having said that, obviously within the category, there's quite a bit of pressure, and we do see a continuing but moderating trend in downtrading.

Vivien Azer - Citigroup Inc, Research Division

Okay. Well, that's interesting to hear. And lastly, in terms of your cost savings, fully understand that you guys promoted and that certainly showed up in your market shares this quarter. But as I think back to your commentary last quarter and the guidance for an acceleration in cost savings, if we looked at your cost savings over the course of the year on an absolute basis, have they in fact accelerated sequentially through the third quarter?

Thomas R. Adams

Vivien, this is Tom. They actually have accelerated. As you recall, we did our business review in the first quarter and began implementing that largely in the second quarter, and it's building into the third and then into the fourth. So it is definitely back half skewed.

Operator

Our next question is from David Adelman of Morgan Stanley.

David J. Adelman - Morgan Stanley, Research Division

Dan, how would you characterize your response to date to -- from a promotional perspective to what's happening competitively? And what would result in the company being more aggressive to try to protect or grow share?

Daniel M. Delen

Yes, David, I think the way I would kind of characterize our response is, we keep a keen eye on balancing obviously the market share performance and company profitability. And I think that's kind of been our stance for quite a while now, and that's the way we continue to look at the business. Obviously, it is very difficult for competitive reasons for me to begin to speculate about what might provoke a change in our stance in the marketplace. But let me just express confidence in terms of our position in terms of what we find ourselves right now.

David J. Adelman - Morgan Stanley, Research Division

Okay. And then maybe as a follow-up, the -- normally, and by normally I mean the last couple of years, by this time of the year, you would have narrowed your earning guidance range. You didn't do that in conjunction with these results. Is that a function solely of the competitive environment you see in the fourth quarter? Is it -- in other words, is there more business uncertainty than would normally be the case?

Thomas R. Adams

David, this is Tom. That is true. So we actually chose to keep our guidance where it was at the end of the second quarter because of the competitive activities that are in the marketplace.

David J. Adelman - Morgan Stanley, Research Division

Okay. And then lastly, Dan, just on Pall Mall and Pall Mall Menthol, you alluded to that in your prepared remarks and in the release, highlighting the fact that the brand's underrepresented in menthol. My question really is, all discount brands are underrepresented in menthol. That's been the case for a very long time. And within that context, how much opportunity do you think there is for Pall Mall Menthol?

Daniel M. Delen

Yes. I think it's a fair observation in the marketplace. I think generally speaking, menthol is a little bit underrepresented in value. Or maybe better said, it's overrepresented in the premium segment of the market. But of course, the lines between premium and value are blurring as we sit here today. We certainly believe that there is well over 0.5 share point potential in Pall Mall -- or additional potential in Pall Mall Menthol in the value segment.

Operator

Our next question is from Judy Hong of Goldman Sachs.

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

First, just -- I'm trying to sort of reconcile the Camel's shipment performance in the quarter. So you head [ph] down 8% in Q3, but the retail market share was down just slightly in the quarter and actually up a little bit sequentially. So in terms of just the shipment versus retail performance for Camel, can you just bridge the 2 for the quarter?

Daniel M. Delen

Yes, I think the -- probably the main aspect that maybe isn't so clear in the numbers, Judy, is that in the third quarter of last year is when we launched Camel Crush Bold. And by actually putting that out in the marketplace, that obviously resulted in volume during that quarter as the pipeline was filled. And that we obviously didn't have any new line extensions on Camel just this last quarter.

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

Okay, all right. And then, Dan, just sort of broadly speaking, I guess this year, clearly the cigarette business has been under a little bit more pressure. You're probably going to have a hard time sort of growing profit this year on RJRT side. You've done really well on the American Snuff and Santa Fe. So if the competitive situation on the cigarette side really doesn't change much in 2013, do you think you can still get to your algorithm in terms of earnings growth without really seeing cigarette business growing because you've got all the levers, whether it's growth in American Snuff or buyback or what have you?

Daniel M. Delen

I think the way I would kind of describe it is I would say is, we're quite confident about our ability to compete effectively in the marketplace. Of course, it's very difficult for me to sit here today and give future projections in terms of how that works. But I'm proud of what our company and our employees have achieved to date and particularly on the brands Camel, Pall Mall and also the ones that you mentioned in terms of Grizzly at the American Snuff Company and Natural American Spirit at Santa Fe Natural Tobacco Company. I'm very proud of the efforts and what we've been able to achieve in this very competitive marketplace to date.

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

And just lastly, just how incremental or how meaningful with your initiatives in some of the other tobacco products, whether it's the Vuse or others have to be kind of in the near, maybe in the medium term to really put the company on a stronger footing in terms of just profit or earnings growth?

Daniel M. Delen

The way I would kind of describe it is, I think they're strategically important initiatives for our company going forward. I think it's very early days in the marketplace, and in fact, it's only been -- they've only been out there for a couple of weeks. So really, it's too early to talk about how meaningful their contribution might be to our business. But I would encourage you and all our listeners to either dial in or attend our Investor Day when we'll actually be dissecting some of those propositions and those brands and really the strategic thinking behind them in more detail.

Operator

Our next question is from Michael Lavery of CLSA.

Michael Lavery

So following up on that a little bit, and maybe you'll just get into all this at the Investor Day, but is there a big push you see behind -- you have several of these new innovation initiatives. Is there a big push you see coming in one over the other? Or do you think that they're all equally important? How -- what's the right way to think about how to put those in context?

Daniel M. Delen

Well, I would say from the 2 initiatives that are relatively new in the market, which is the e-cigarette side and the NRT product, I would say that both have substantial potential in the marketplace, but both are still in very limited distribution as we sit here today. So I think it's a little bit early to actually be indicating the prioritization and which might have more market potential than the other.

Michael Lavery

And on the e-cigarette side where there's presumably comparable products in the marketplace that seem to be growing, is there a reason you're taking a what seems to be a more cautious approach as opposed to a bigger launch?

Daniel M. Delen

I think it's fair to characterize our product as being substantially different than anything else in the marketplace. This is a sort of organically developed -- it was developed here in the U.S. and manufacture is also U.S.-based, so it's a substantially differentiated product in the marketplace. And we're quite excited actually about its potential of being successful in the marketplace, but also being quite unique and differentiated in the marketplace.

Michael Lavery

Can you give a sense of what differentiates it?

Daniel M. Delen

Well, I would say, we would certainly point to really 3 aspects of that. We would say it's different from a product efficacy point of view, it's different from a product quality point of view and it's different from a stewardship point of view as well.

Michael Lavery

Sorry, stewardship is the last one?

Daniel M. Delen

It's just about some of the potential kind of health impact in that category.

Michael Lavery

Okay. And then, just to help me understand in the quarter, too, if you can, you say that the non-focus value brands were the main driver of the shipment decline, but if I look at the numbers, it looks like the premium -- where you call out total premium declined by 700 million, 800 million sticks or about 7% and the value was down about 500 million or closer to 6.5%. So is it closer to an even split or even skewed towards premium, or was there someway the value really was the driver?

Daniel M. Delen

I'm sorry, Michael, could you repeat the question? I'm not sure I was quite tracking.

Michael Lavery

Yes. So in your prepared remarks, you had mentioned that the non-focus value brands were the main driver of the shipment decline for cigarettes. But I just want to reconcile that with the numbers in the table where it shows that total premium cigarettes going from 10.7 last year to 10 this year and total value from 8 to 7.5. So in percentage terms, their declines were fairly similar, and on the premium side, the absolute decline was like -- it actually was bigger.

Daniel M. Delen

Right. Yes, I think the way to kind of think about our -- the other brands that we have, the ones that we're not focusing on, and those are Winston, Salem, Kool and Doral. If you take a look at the actual declines that were generated there, about 1/2 of that was in Doral. And Doral is a value brand out there, whereas the other 3 are premium brands in the marketplace. And that sort of contributed to that mix, if you want, that you see.

Operator

Our next question is from Bonnie Herzog of Wells Fargo.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Dan, I just have a follow-up question on promotional spending. I understand you are stepping up your promotions quite a bit behind your key brands in November. Can you talk a little bit more about this decision, and then what other tools or levers you have to pull to help turn your volume performance around?

Daniel M. Delen

Well, Bonnie, I think, the way I would kind of describe our activity, first of all, in the month of November, I think it is geographically-based and obviously, there are sort of key styles and key brands that come into play quarter-to-quarter and month-to-month. And that obviously is an important lever on the brand. But we pride ourselves actually on the equity behind the brands that we're building over time. So of course, from a pricing point of view, you need to be in the range, you need to be sort of competitive, but that isn't the long-term differentiator for our key brands. The long-term differentiator is actually, as I've mentioned, the equity and imagery behind our brands. And that, I think, can be best reflected by the superior demographic profile of our brands, particularly in Camel, in Premium and Natural American Spirit and Super Premium.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Okay. And then, Dan, I'd love to get your thoughts and I guess your long-term view of the health of the industry's profit pool, and then realistically, is it at risk? I guess, how long do you expect the competitive pressures to remain elevated? Is it another year, or could this continue longer? Just love to get your thoughts on how you see this playing out over time.

Daniel M. Delen

Yes. Thanks, Bonnie. I think you know that certainly over the long term, and when I look at the long-term future of the category, I do believe that the profit pool is fundamentally healthy and that there are good opportunities for the profit pool to grow long term. Yes, I think having said that, I think it's fairly obvious to everybody on the call today that the profit pool certainly has been a little bit less healthy over the more recent history. I think it's very hard for me to speculate when we might actually come out of this period of increased competitiveness. Yes, and I think that question might be better asked at subsequent calls this week.

Operator

Our next question is from Chris Growe of Stifel, Nicolaus.

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

I'll be sure to ask that question in future calls, too. I just want to ask you a quick question, if I could. You talked about how your savings, Tom, are picking up through the year, which we knew because of the restructuring activity. And I know that you always have some ongoing programs internally that really keep a close eye on costs. I'm just curious, a bit of a follow-on to earlier questions, is there anything you're doing internally differently today than maybe you were doing a quarter or 2 ago just because of the promotional environment or competitive activity to try and prepare for that continuing? Are there more cost-saving programs or things that you're doing to help prepare for that?

Daniel M. Delen

Well, Chris, as you said, we have ongoing programs above and beyond the restructuring that emanated from the business review that we announced in the first quarter. And we continue to focus on that, and we look at just the cost in the organization. We also look at promotional efficiencies and how we deliver those promotions to the consumers and can we do it in a more efficient way. So there's a big landscape out there, and we're looking at all of it. And clearly, we've demonstrated through our history that we're pretty good at working the cost side of the equation, and we haven't lessened up on that at all.

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

Okay. And I guess, somewhat related to that, the -- if you look at the way your promotional spending is going -- we know there's some increases coming up, and you certainly have some new products behind Pall Mall. So as you are -- whether it's efficiency or it's pulling back on some brands and increasing it behind Pall Mall, I guess I just want to understand, your net promotional spending for the overall cigarette division, is that up? Will it be up maybe more in the fourth quarter? Are you willing to talk about that?

Daniel M. Delen

Well, I think in a general sense, we can talk about that. I think it's fair to characterize our total promotional spending as being up. But I think some of the key numbers, maybe just to keep an eye on, although it's up if we take a look at our net price realization for the quarter, it's about 3%, which certainly by any measure is nothing to sneeze at and that is x contract manufacturing. So x the price realization we get for the products we manufacture for BAT in Japan. And then also, if we take a look at the adjusted operating margin, we came in -- this is total RAI, the third quarter -- 36.1%. That is a sequential change of 1.9 percentage points, and year-over-year, it's a 2 percentage point change. And I think that is the way we would kind of look at the business and say that we are financially being good stewards of the company despite some of the very intense competition out there.

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

Okay. And just one quick follow-up, and that would just be in relation to your new Pall Mall products, do you expect -- do you have -- where do you expect to source the volume from, I guess is really my question? Is that -- is it just amongst the low-end? Or do you think there's going to be trade-down from some of the premium brands, and to what degree is that a risk for Camel?

Daniel M. Delen

I think it's a combination of different sources. I think some will come from other value brands out there. I think a fair amount will come from the premium segment. And Pall Mall historically over time has sourced the majority of its share gains actually from the premium segment. When we take a look at Pall Mall vis-à-vis Camel, don't forget from a product differentiation point of view, they are substantially different. We have the capsule products in Camel, and these are more classic, i.e., products without capsule, that we've launched on Pall Mall. So I think we're prepared for a little bit of impact on Camel, but I think the more significant proportion will come from competitive premium smokers.

Operator

Our next question is from Priya Ohri-Gupta of Barclays.

Priya Ohri-Gupta - Barclays Capital, Research Division

Just wanted to ask about your expectation around refinancing or tapping the debt market. It looks like, consistent with your prior commentary, you do have sufficient cash built up to pay down the term loan into the current quarter using cash. But given your maturity next year, as well as the current financing environment, how should we think about your needs to come to the debt market?

Thomas R. Adams

Well, we do have sufficient cash to pay down the term loan, and in fact, we paid an additional $100 million down in the early part of October. We are looking at the debt markets in the relative near term. We see rates as being favorable, and we would use the proceeds from any offering when we do it to basically pay off that $685 million that's coming due in June and in August of next year.

Priya Ohri-Gupta - Barclays Capital, Research Division

Okay, that's helpful. And if we think about what potential sort of tenors you might look to do?

Thomas R. Adams

Well, I would say that when we go to the markets, we'll be tenor-focused, so we'll be looking at 10s and 30s and perhaps some relatively short as well. We'll make that determination when we get to the market.

Operator

Our next question is from Andrew Kieley of Deutsche Bank.

Andrew Kieley - Deutsche Bank AG, Research Division

Dan, I wonder if -- just quickly, if you could talk about your comfort with the price gaps in smokeless, and how that relates to, I guess, Grizzly's ability to maintain this higher level of volume growth going forward?

Daniel M. Delen

Yes, I think, honestly, I'm relatively comfortable with the price gaps. If we take a look at Grizzly's performance certainly over the last few years, and that's really continued up until now, we see Grizzly as fundamentally very healthy as we sit here today. It came in during the quarter at 28.8%, and that's actually up 1.2 share points year-on-year. And that is despite the price gaps having closed very significantly over the last years and despite the launch of, very similar to what's happening in cigarettes, of premium value line extensions both on Copenhagen and on Skoal. And I think it's a fundamental reflection of just how strong the Grizzly equity is out there in the marketplace, the strong following it has and fundamentally the fantastic product that's in the can. So I would say that we're very confident in terms of what we have executed on Grizzly and about its future potential in the marketplace.

Andrew Kieley - Deutsche Bank AG, Research Division

Okay. And then just a second question for you, as well as Tom, I guess. When we're thinking about the implied guidance for the fourth quarter and the range there, is the wideness there? Is that just a function primarily of seeing how effective some of those stepped-up promotions you're doing will be in the fourth quarter? Are there -- just trying to think about puts and takes for your outlook.

Thomas R. Adams

It is the reflection of that, as well as the other competitive activity that we've observed in the marketplace throughout the year, which we see continuing into the fourth quarter thus far.

Operator

Our next question is from Karen Lamark of Federated Investors.

Karen Lamark

Couple of questions. First, on Santa Fe and American Spirit. Can you talk a little bit about where the growth in volumes is coming from? New users, more frequent or loyal users, distribution, et cetera? And sort of give us some color on the opportunity going forward, and if we should expect the same sort of cadence in terms of the fundamental growth there.

Daniel M. Delen

Okay. Yes, thanks for that question. I mean, I really think that the people at the Santa Fe Natural Tobacco Company who manage the Natural American Spirit brand really are firing on all cylinders. And when we look at this brand, and you mentioned some of the potential sources of this growth, I would say the answer is, all of the above. What we see the brand is it's really firing on all cylinders. It's growing very significantly in the markets where it already is strong. Having said that, it's growing at the same rate, but obviously off a smaller base in some of the markets where it's less strong. A couple years ago, we did have a significant sort of increase in distribution out there, but that was really just distribution catching up to existing demand. And so when we look at it, any way that we look at it, even from a consumer franchise point of view, we would see new people continuing to kind of try the brand, but also convert to the brand. So we see increasing levels of trial and conversion as we go. So I really believe that the Santa Fe Natural Tobacco Company's story is very robust, and see no reason why that fundamental marketplace growth should not continue. I think there's one aspect of the brand that's sort of embedded in the numbers that we released today that is maybe a little bit less repeatable, if you want. And that has to do with the adjusted operating margin on the brand, which came in -- for the quarter came in at 50.5%, and year-on-year, that's actually increased by 7.4%. That is a reflection of some of the -- a lot of the back office processes for the Santa Fe Natural Tobacco Company that have actually been incorporated and now provided by RAI Services Company, so call that a shared services of some of the back end things. That's actually had a significant impact on the adjusted operating margin year-over-year, but that obviously is not something that repeats in the out years.

Karen Lamark

Okay. And then separately, if I'm correct, the pace of your buybacks in the quarter was a bit higher than you all had guided. And I'm wondering if maybe a step-up is indicative of your future plans for buybacks and/or when you might expect to complete the authorization.

Thomas R. Adams

It's really not indicative of anything other than we wanted to go a little bit heavier in the third quarter and perhaps lighten up a bit in the fourth quarter. So we're just being -- I wouldn't read anything into it beyond that. We're still on pace to do about $1 billion a year. And we would expect -- at this point, we would expect to finish the program in the early part of 2014.

Karen Lamark

Okay. So just to clarify, Q4 is likely to be less than the sort of 2.50 per quarter run rate than you had guided to. Is that fair?

Thomas R. Adams

Well, we'll take a look at what the share price looks like, and we'll make our determinations as we move through the quarter.

Operator

[Operator Instructions] Next question is from Thilo Wrede of Jefferies.

Thilo Wrede - Jefferies & Company, Inc., Research Division

Dan, I had a more of a conceptual question for you. Do you have internally a margin target both for RJRT and American Snuff Company that when you reach that target, you would decide not to necessarily grow margin anymore, but for example, invest in price? And I don't expect you to talk about what the target would be, but more conceptually.

Daniel M. Delen

Well, I think, Thilo, you know sort of in terms of the interaction that we've had over time that we do watch our adjusted operating margins very closely. And that is a good guide for us as management just to see how well we're doing in terms of taking some of the market share numbers that come through and actually being able to convert that into operating income. And we do internally to ourselves set targets that way, and it's important. So I would say conceptually, a conceptual answer to a conceptual question, the answer would be, yes. Yes, and I think we're quite proud of the history that we've been able to demonstrate in terms of growing our adjusted op margin really over many, many years now and over many quarters.

Thilo Wrede - Jefferies & Company, Inc., Research Division

And when you talk about balancing market shares and profitability, are you talking about profit margins in the profitability part, or are you talking about actual profit dollars?

Daniel M. Delen

I think it's both.

Thilo Wrede - Jefferies & Company, Inc., Research Division

Okay. So right now, profit dollars at least for RJRT are declining, but does that mean you're falling short of your goal or is that more a temporary blip? How would you characterize that?

Daniel M. Delen

I think really, when we look at this, we would look at it over the long term and see where the long term kind of trends and picture and outlook actually lie. I think obviously, quarter-to-quarter, year-to-year, you have different competitive pressures, different brand dynamics. The economy changes over time. So I think we really look at these numbers relative to the environment that the brands and consumers find themselves in.

Operator

This ends the Q&A portion of today's conference. I'd like to turn the conference over to Mr. Morris Moore for any closing remarks.

Morris Moore

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

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect, and have a wonderful day.

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