First Quarter 2009 -- At a Glance
·Adjusted EPS of $1.00, unchanged versus year-ago quarter
·Reported EPS of $0.03, including non-cash trademark impairment charges of $0.97
·Volume declines reflect significant trade inventory reductions driven by federal tax increases
·R.J. Reynolds posts additional growth-brand share gains
·Conwood maintains moist-snuff growth momentum
Grizzly posts 2.6 share-point gain
·Camel broadens smokeless innovations
·2009 guidance: Adjusted EPS range of $4.15 to $4.45
Excludes any trademark impairments
Includes $0.40 year-over-year increase in pension expense
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All references in this release to "reported" numbers refer to GAAP measurements; all "adjusted" numbers are non-GAAP, as defined in schedules 2 and 3 of this release, which reconcile reported to adjusted results for the first quarter.
Reynolds American Inc. (NYSE: RAI) today announced first-quarter 2009 reported EPS of $0.03, which includes non-cash trademark impairment charges of $0.97 per share. Excluding impairment charges, adjusted EPS of $1.00 was unchanged from the year-ago quarter, as the effect of cigarette volume declines and higher pension expense was offset by higher pricing and productivity at both reportable business segments. RAI said it expects full-year adjusted EPS of $4.15 to $4.45, which excludes any trademark impairment charges, but includes a $0.40 year-over-year increase in pension expense.
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MANAGEMENT'S PERSPECTIVE
Overview
"The tobacco industry was marked by significant shifts in the first quarter. However, the fact that both of RAI's reportable operating segments continued to post increases in adjusted operating income highlights the strength of the total-tobacco business model we've established over the past several years," said Susan M. Ivey, RAI's chairman, president and chief executive officer.
Ivey said that changes in industry pricing dynamics, along with trade inventory reductions in response to federal excise tax increases, made for a challenging quarter.
"The unprecedented increase in federal excise taxes on tobacco products that took effect April 1 disrupted first-quarter cigarette and moist-snuff shipments," Ivey said. "As a result, there were significant reductions in wholesale and retail inventories, and that caused higher-than-usual industry volume declines. The tax increases, as well as pricing changes, also triggered trademark valuations that resulted in impairment charges on some of our companies' non-growth brands.
"In light of these factors, we're pleased with our first-quarter adjusted results, which underscore the resilience of our total-tobacco approach," Ivey said.
Ivey also noted that in the first quarter:
·R.J. Reynolds again posted share gains on its two growth brands, Camel and Pall Mall;
·Conwood continued to capture the majority of total moist-snuff category growth, with additional share and volume increases on its powerful Grizzly brand; and
·Higher pricing and productivity at both companies helped offset the effect of lower cigarette volume and higher pension expenses compared with the prior-year period.
"Based on first-quarter performance, and the challenges and opportunities we anticipate during the year, RAI expects to deliver adjusted EPS of $4.15 to $4.45. That excludes trademark impairment charges, but it does include the negative impact of higher year-over-year pension expenses of about $0.40 per share," Ivey said.
Commenting on RAI's underlying stability, Ivey said, "For a number of years, we've been building a total-tobacco infrastructure that includes the nation's second-largest cigarette and smokeless tobacco companies, as well as the leader in the super-premium cigarette segment.
"This combination of tobacco businesses, with their powerful growth brands and their focus on innovation and productivity, provides a strong foundation to build value for our shareholders now and in the future."
R.J. Reynolds
"We anticipated this year's challenges and opportunities, and we have tailored our structure and strategies to succeed in the evolving tobacco environment," said Daniel M. Delen, R.J. Reynolds' chairman, president and chief executive officer.
"We carefully restructured R.J. Reynolds last year to support our intense focus on growth through innovation, coupled with strict cost control. This positions us to compete effectively in traditional product categories and invest in new product innovations to meet changing consumer preferences," he said.
R.J. Reynolds' first-quarter adjusted operating income of $459 million, which excludes non-cash trademark impairment charges, was 7.7 percent higher than the prior-year period. The company's first-quarter adjusted operating margin of 27.5 percent was up 3.9 percentage points.
Higher pricing and productivity helped to more than offset the impacts of an unusually high decline in cigarette volume and a year-over-year increase of about $45 million in pension expense.
"R.J. Reynolds' cigarette shipment volume declined 10.5 percent, consistent with the industry decline of 10.4 percent," Delen said. "Factoring out the wholesale inventory reductions associated with the federal tax increase, our first-quarter volume decline would have been about 8.1 percent. I will point out, however, that we're seeing trade inventories returning to more normal levels."
R.J. Reynolds' total first-quarter cigarette market share was 27.7 percent, down 0.7 percentage points, as growth-brand share gains of 0.8 percentage points were offset by declines on other brands.
In January, the sampling model that the company's vendor uses to estimate R.J. Reynolds' retail cigarette market share was refined to better reflect actual retail activity. This refinement changed some share numbers, but did not affect overall share trends.
Camel, the company's flagship brand, posted first-quarter cigarette share of 7.6 percent, up 0.1 percentage points. That gain came from the brand's core styles and its latest cigarette innovation, Camel Crush, which offers adult smokers the choice of regular or menthol with each cigarette.
"Camel Crush is an important element in the brand's focus on menthol growth, and it continues to perform well," Delen said. "During the first quarter, Camel Crush had a market share of 0.6 percent, with broad appeal among both regular and menthol smokers."
Camel Snus, R.J. Reynolds' first modern smokefree tobacco product, was expanded nationally based on the positive response it has received from adult smokers in lead markets during the past three years, he said.
He also said that R.J. Reynolds introduced its first dissolvable tobacco product, Camel Orbs, in three lead markets during the first quarter.
"Dissolvable tobacco products directly address consumers' frequently voiced desires for tobacco products that are convenient, discreet and don't bother others," Delen said. "We'll gain valuable learning in lead markets this year, and we remain committed to driving meaningful innovation in the tobacco category."
Pall Mall, R.J. Reynolds' second growth brand, is a high-quality, longer-lasting cigarette at an attractive price. Its first-quarter market share was 2.9 percent, up 0.6 percentage points from the prior-year period.
"Pall Mall's high-value appeal plays an important role in R.J. Reynolds' growth strategy, especially given the current economic environment," Delen said. "Pall Mall has steadily gained share over the past three years. The refinements we made to the brand's promotional strategy last year continue to generate high levels of trial and conversion."
He said that R.J. Reynolds remains intensely focused on continuous productivity improvements, including efforts to cut costs by reducing complexity.
Since the merger in 2004, the company has reduced its product portfolio from more than 800 cigarette brand styles to less than 400. This reduction also benefits the company's trade partners, letting them focus on R.J. Reynolds' core brands.
In addition, the company's restructuring last year will generate about $35 million in savings this year.
"We remain committed to strengthening R.J. Reynolds' core cigarette business, developing innovations that meet the emerging desires of adult tobacco consumers and keeping our costs in line," Delen said.
Conwood
"Conwood posted another strong quarter, with increases in volume, share, margin and earnings," said Bryan K. Stockdale, who became Conwood's president and chief executive officer on Feb. 1.
Excluding trademark impairment charges, Conwood's first-quarter adjusted operating income was $84 million, up 3.0 percent from the prior-year period. Its adjusted operating margin was 50.5 percent, up 1.7 percentage points.
"We delivered excellent results despite significant increases in promotional activity from competitive value brands, as well as premium price reductions that narrowed the gap between Grizzly and its premium competitors in southeastern states," Stockdale said.
He added that temporary disruptions in industry shipments, due to the federal tax increase announced in the first quarter, held Conwood's total volume growth to less than 1 percent. However, Conwood's share of moist-snuff shipments increased two full share points, to 28.8 percent.
Driving Conwood's growth was Grizzly, which strengthened its position as the nation's leading moist-snuff brand, with a 24.7 percent share of shipments in the first quarter. Grizzly's powerful brand equity as a high-quality product at a reasonable price delivered volume and share gains that far outpaced all its competitors.
"Grizzly's share gain of 2.6 percentage points was more than six times larger than the growth on any other brand," Stockdale said, "and Grizzly's unit volume gain was larger than that of all other competitors combined."
Grizzly's two newest pouch styles -- Mint and Straight -- were introduced nationally in the first quarter and have already captured a combined 0.4 share points. Grizzly's core styles continued to deliver strong growth, with a 2.2 percentage point gain from the prior-year period.
Conwood's premium Kodiak brand's 3.8 percent share was 0.6 percentage points below the year-ago quarter. However, the company has announced a list-price reduction to bring Kodiak's price in line with other premium brands and make it more competitive. Conwood expects this pricing change to improve the brand's performance, Stockdale said.
As part of efforts to improve its position in the premium segment, Conwood plans to introduce two innovative moist-snuff styles under the Camel brand name in two lead markets this summer.
Camel Dip, which comes in two styles -- Wintergreen Wide Cut and Dark Milled -- offers a new-to-the-market tobacco cut and innovative packaging that provide meaningful points of difference for moist-snuff consumers.
"Blending the strength of the Camel brand name with Conwood's expertise in moist-snuff product innovation is a winning combination," Stockdale said.
Stockdale said that 2009 will present its share of challenges. "The federal tax increases have made our roll-your-own and little cigar products significantly more expensive, and we expect to see a negative impact on those products," he said.
But at the same time, he said, the tax increase on cigarettes was larger than that on moist snuff, making moist-snuff more attractive to adult smokers who appreciate better value and smokefree ways to enjoy tobacco.
"The exceptional power of Grizzly and our commitment to developing innovative smokeless tobacco products will serve us well in this changing tobacco environment," Stockdale said.
FINANCIAL UPDATE
"Given the industry's first-quarter volatility in pricing and shipments, I'm pleased with RAI's performance," said Thomas R. Adams, Reynolds American's chief financial officer. "R.J. Reynolds and Conwood both increased adjusted operating profits and margins, and continued to strengthen their core brands with innovations to support RAI's future growth."
RAI's reported EPS of $0.03 included non-cash, pre-tax trademark impairment charges of $453 million, or $0.97 per share, triggered by federal tobacco-tax increases and changes in pricing.
"In addition to trade inventory reductions, our adjusted earnings of $1.00 per share were negatively impacted by $0.10 of increased pension expense and an additional $0.09 from non-operational factors that included lower interest income and higher expenses on some other financial items," he said.
Adams said that RAI continues to focus on productivity and noted that the company expects to achieve restructuring savings of about $40 million in 2009, growing to $55 million a year beginning in 2011.
He also said that RAI's balance sheet remains strong, with $3.2 billion in cash at the end of the first quarter. "In keeping with our conservative approach," he added, "even after making our required annual Master Settlement Agreement payments on April 15, our cash balance remains above $1 billion."
RAI bought $207 million of its shares under the $350 million share repurchase program, which ends April 30. "To preserve liquidity, we didn't make any purchases under this program in the fourth quarter of 2008 or the first quarter of this year," Adams said. "We have no plans for another share repurchase program at this time."
Adams reiterated RAI's commitment to returning value to shareholders through its 75 percent dividend payout policy, which currently delivers $3.40 per share on an annualized basis.
He said that RAI's expectations for full-year earnings of $4.15 to $4.45 per share includes a year-over-year increase of $0.40 in pension expense, but excludes any trademark impairment charges.
"At this point it is difficult to precisely predict the full effect of the federal tax increases, so our guidance range is wider than usual," Adams said. "Nonetheless, we feel confident that RAI will fully meet the challenges and avail itself of the many opportunities ahead." Enditem
