COMPANYPROFILE

ReynoldsAmerican acquisition of Conwood Company, the nation's second-largestsmokeless to- bacco company. Third-quarter revenue climbed nearly2 percentto $2.19billion RollsForward from $2.15billion lastyear. r orftJfue tobaccogiant overcomeschallenges of the While the external businessenvi- industry through ronment has become considerably the strengthof its brands and favorablethan it was severalyears an innovativemarketing approach - aswell asa ago, non-traditional businessfactors - highly touted entry into the smokelesscategory. mostly lawsuits,smoking bans, and tax increases- continue to challenge ReynoldsAmerican, aswell asthe entire espitea challengingbusiness en- to just another day at the office for the industry. Nevertheless, Reynolds

+^1-^--^ ^i^-+2 vironment, ruudr!u SrdrrL; Americankeeps roiling along. Inc. (RAI) continues to move RAI had about $8 billion in annual forward thanks to its creative acquisi- salesand holds 30% of the U.S. market. BRANDSTRENGTH tions and sav\y management.But are Its third-quarter profit rose 45%o,with In 2005RAI's largest subsidiary, R.]. litigation, smoking bans,tax increases continued strong performanceby R.l. Reprolds,launched a new portfolio strat- and intensifyingcompetition taking a Reynolds Tobacco Co.'s and egy aimed at improving profitability. A toll on the second-largestU.S. cigarette Kool cigarettes,as well as moist- key part ofthis wasto createthree brand manufacturer- or doesit all boil down snufi which came as part of RAI's May categoriesfor its products.Camel and

14 NOVEMBER2006 TOBACCOINTERNATIONAL "investment \.ro1 \vereselected as prod- third quarter was marked by the con- support brands as marketing efforts are -r;ts" and as suchreceive the majority of tinued strong growth momentum of reduced or eliminated. Further, we see larketing support.Winston, Salem,Do- Conwood. increasedcompetitive pressures in the ::1. and are "selectivesupport" "Our performanceis on track for menthol category,limiting growth for -.randsand receivelimited resourcesas RAI to again deliver strong full-year re- RAI's mentholbrands." .he companytries to get greaterefficien- sults," Ivey said."We are increasingour S&P'sRAI outlook has improved, ;ies out of them. The remainingbrands full-year forecastbased on additional noting a new marketing strategyand se- taLlinto RAI's "non-support"category. gainsat R.).Reimolds and Conwood." cure price increasesas two key positive With this strategy,R.l. Reynoldsin- "ReynoldsAmerican has offered in- elementsbolstering RAI's short-term tendsto accelerategrowth of its two in- vestorsan extraordinarylevel of wealth prospects.The fact that Camel and Kool \.estment - brands Camel and Kool - creation.Even though it hasn't been have continuedto grow market sharein so their growth exceedsdeclines on the smooth sailingas of late,the stockhas a dynamic and challengingmarketplace company'sother brands. In this way, returned better than 26% annually over is another encouragingsign. S&P also the company plans to reverseits de- the last five years," saiciPeter Gore, cites "synergies"generated from recent clining share-of-markettrend and gen- CFP of financial advisory firm Gore & mergersand acquisitionsto begin favor- eratetotal company sharegrowth be- Golub LLC in Williamsburg, Va. "Late- ably contributingto RAI'sbottom 1ine. trveen2010 and 2012.Since the new ly, managementhas been prone to sur- During the third quarter, R.J. portfolio strategy was introduced, prise againstestimated earnings, best- Reynolds'"investment brands" Camel Camel and Kool have grown more than ing the overhanginglitigation cloud. and Kooi continuedto post strongshare a full sharepoint on a combined basis, There still is a compelling story for gains,with a combined increaseof 1.07 and R.l. Reynoldshas cut its rate of to- RAI. That's not to say there is no risk sharepoints comparedwith the year-ago tal declinein half. associatedwith it but the tobaccoin- quarter.On a nine-month combinedba- The introduction of the new brand dustry is still a considerableforce to be sis. the company s two investment strategycame on the heelsof highly pub- reckonedwith." brandswere up 0.9'lshare points com- licizedmerger-and-acquisition activity that includeda mergerwith the U.S. op- erationsof No. 3 U.S. cigarettemaker Brown & Williamson (2004)and acquisi- tions of Lane Limited (2004) and Santa Fe TobaccoCo. (2002).Synergies from the B&W merger have aireadyprovided Rep-roldsAmerican with some $600 mil- lion in annual savings. "ReynoldsAmerican's year-to-date resultsunderscore the power of our busi- nessmodel and our operatingcompa- nies' inherentstrength," said SusanM. Ivey, RAI's chairman and c.e.o."Nine- month profit gainsfrom eachof our op- eratingunits contributedto continued growth momentum. Our performance continues to validate that our strategyis solid,and is dliving results." "We expectrevenues to rise about paredwith the prior-yearperiod, con- Ivey said that continued total share- 6010,"said Standard& Poor's (S&P) ana- tributing to the continuedmoderation of trend improvements at R.J. Reynolds lyst Raymond Mathis. "We seea likely its overallshare declines. are in line with those expectedfrom the rise in volumes for focus brands Camel "Reynoldsstill needsto seean even brand-portfolio strategyit put in place and Kool but anticipatecontinued vol- more significantimprovement in the op- in early 2005. She also said that the ume declinesfor select-supportand non- erating margins for its cigaretteopera-

NOVEIV]BER2006 TOBACCOINTERNATIONAL 15 ...>COMPANYPROFILE

tionsbefore it canproduce the samelevel lion "investment" to fight state-ballot feat this [California] initiative until it is of profitability reported by most of its initiatives on cigaretteexcise-tax increas- in the hands of the voters," Ivey said at peers,"noted GreggoryWarren, CFA, a es and smoking restrictions,much of it the time, adding that the company was Morningstar analyst."The company's in California. Other smoking-ban and investing more than half of its opposition heavier focus on discount brands has left ta-r fights were on the ballot in Arizona, budget in California alone. "Voters have it well behind Altria and Carolina Group, Nevada,Ohio, South Dakota and Mis- to make a good decision on Nov. 7, both of which have stronger portfolios of souri. Thesetlpes of opposition strate- whatever that decision is." Re;'nolds de- premiumbrands and generateoperating gies are becoming part of every giant to- rives some 6% of its salesin California. margins in excessof 30o/oannually." baccocompany's long-range plans. (Editor'sNote: The resultsof that in- Part of RAI's strategywas its $40 mil- "The companyisn't letting up to de- vestment,post-Election Day, were mixed for Reynoldsand the otherbig U.S.tobac- co companies:I\'ltile vlters shot down the In the Boardroom hugetax hike proposedin the crucial state of California, as well as Missouri, they of directors*lect*cj icffrey A. f*kmann, 54, i* gr*up presi- R,A!'sboarci approvedballot measuresin Arizona, dentil Sct*her.Previor-isly he had been *.v.[. nf strat*gyand bi:siness de- Nevada and Ohio to require smoke-free velopmer'ltfor the *orflpnny"i-{* will al$oheve $ngcir}g aflrolintab;lily f*}" public places,and to in- RAI'sstrategy and hlusine$sdev€lopr*ent filnctioils. Hrkffiann was fnrmerly workplacesand seninrvic* presidentand chief financiai cfficer *i Br*wn& WilliamsonT* creasetobacco taxes in South Dakota and baccoCurp" {B&W} aild l*d ihe in;*grationof that conipany'sU.$' *iga- Arizona.) reiteaild tabacco business with R.J.Reynol'Js Toba*co *4. ir Juiir?*il4. RAI's total retail market sharefor E. Juiia'uJildy"Lamb*t*: jo!ned ihe clrnpanyas e.v.p' eild gen*rfii the nine-month period was 29.870/0, coilnseleffectlve in $eptemb*r.L*rnbeth,55, wiil al30s*rvs es e'v"p"end down 0.35 points. Spendingto combat R.-i.R*ynalds Tohecc* tc" generalcounsel af RAI': largestsubsidiary, stateballot initiativesand an 8% voi- succe*diilgCharl*s A. Blrxt,'whohas retired after ?1 y**r$with the c*m- ume decline that was partially driven by Fanir.pr*urolisly Lamh*th had beenat DuFoiita*d Coil*coFhi!lipx,h*th trade-inventory movements weakened drnrestinallyarld internaticnaliy. LynnJ" **asleyvrrill retire as presidentCIi n."i. ft*ynaids'Icbacc* ea. at RAI's results. the startof the newyear and be r*placedby the presiilf;niof BritishArneri- canTcbacc* Ltd.-J*pan. SMOKELESS:THENEW FRONTIER? DanietrM. CIeic*u;ill repl*ce Bea*ley ori Ja*. 1, thoughB*asley will re- Conwood, acquiredfor $3.5 billion, de- maino!"i bnard thrr:ugh mid-Fcbruary to *asethe transttion" livered strong growth for the third quar- jcined !n 1382 as e m€rketingass!sia:rt *easlsr/ ReyncldsTcbacco ter and the first nine months with ad- ai"idrcse ihr*ugh th* rankst* bec*ryreexecutive viee presid*:niof rflfir- justed operating income rising 7.4% to ketingin 1"997.She v;as named pfesident *nd chief*ilerai:ng aif!cer in million. The formerly privately heid Jenuary20il2. $73 Delenwas named $eni*r vice president c{ mark*tingand sal*: in ?*il1 company is a large player in the moist- for fiAT'sformer U.S. unit Brcwn& Williarns*nTi:bacc': eorp", which is snuff category largely thanks to Grizzly, nowa fiartCIf F?JR, and bec*mepresid*ilt of BAT'sJapan buu:"ress ilnil in a price-valuebrand that holds 20% of Aug*si?C*4. the market. It nabbeda 3.7 share-point In ctherRAI perscnnelffiilves, Reyn*ids American anncurced ihe pr*- gain for the first nine months compared h:;mai':rescilrce$ moiion$*f l-is* -H.fialdwell tt s+niorviee ilresideniof with the sameperiod of 2005. Ksrl trr*hitehurstto senicrvic* presidentnf strategy*nri b,:sinc35d*- and Conwood manufacturesand sellsin velopmeilt.Caleiwell haei been vic* prestdcntnf h*rnanres*ur.*5, wnlie every smokelesscategory, including lqJhitehursthad been v!ce nresident of inve*tari'slilt!ons. moist and dry snuff, loose leaf, plug and twist tobaccos.It is the growth leaderin moist snuff, and Grizzly is the leading value brand. Conwood's net saiesfor 2005were more than $450 million with annual saiesgrowth over 87o during the last five years.Conwood's president and Fram leftto right:Reynolds executives Jeffrey Eckmann, Judy Lambeth, Ken c.e.o.Bill Rossonreports to RAI group Whitehurstand LisaCaldwell. presidentleff Eckmann, who also leads

16 NOVEMBER2006 TOBACCOINTERNATIONAL . ".>. COMPANYPROFILE

the company'sLane, Santa Fe and GIob- al Products subsidiaries(see "In the ...prtThere Boardroom,"page 16). areother companies "We're excitedabout Conwood's interestedin smokeless....The growth prospects,"said Ivey. "Con- wood's strong,well-positioned brands competitiveenvironment will be are gaining sharein the growing moist what it will be.t' - DianneM. Neal, cFo snuff market, and its high margins will enhanceour ability to continue to pro- vide an excellentreturn to our share- bled its total shareof the moist-snuff 24.5o/oof U.S. salesvolume. Midnight holders." market during the lastsix years. Special,a value brand that has under- Conwood brands include H.B. ReynoldsAmerican will combine its gonerapid growth over recentyears, has Scotts,Morgan's, and Levi Garrettin the Lane Limited subsidiary, currently 7.60/oof retail volume. Kite, launchedin loose leaf category;Kentucky King and headquarteredin Tucker, Ga., with 1934,is the leadingmenthol RYO in the Moore's Red Leaf in the Twists group; Conwood in order to drive growth in United States,with 5.2o/oof retail sales Dental Mild and Sweet,and the companies'portfolio of other tobac- volume. Four other RYO brands - snuff; Taylor's Pride, Cannon Ball, and co products (OTP). The headquartersof Samson,Roll Rich, Jester,and Gauloises Black Maria in plugs; Grizzly and the combined companieswill be in (marketedon behalfof the Europeanto- Cougar in the moist price-value seg- Memphis, Tenn., and fuil integrationof baccocompany Altadis) - accountfor a ment; and Kodiak and Hawken in the the two is expectedto be completedby further 1.4o/o,gling Lane 38.8%of total moist-premium group. It is the only year-end2007. U.S. RYO salesvolume before affiliating company to competein a1lfive smoke- Lane Limited has the leading roll- with Conwood. lesscategories, holding the No. 1 or No. your-own brand in Bugler.Launched in Additionally, Lane marketsWinches- 2 position in each.It's more than dou- the United Statesin 1932,it accountsfor ter little cigars,the biggestlittle-cigar

18 NOVEMBER2006 TOBACCOINTERNATIONAL brand, with 15.9%of U.S. little-cigar contract for ser-vicesrelated to the distri- shareholdervalue and are certainlycon- saleswhile Captain Black accountsfor bution of Lane products for one year. tributing to the continued strong stock t' Lane also markets Dr. Grabow is the best-sellingbrand of 4.4o/oof the category. -prfnrmanre the Dunhill Aged and the Dunhill pipesin the United States,annually pro- On a competitive front, Swedish Signedranges of premium cigarsin the ducing some250,000 pipes. Match announced in October that it will United Statesunder an agreementwith "This sale allows Lane to more fully partner its North American unit with British AmericanTobacco, plus 20 styles focus on its core businessand growth Lorillard TobaccoCo., the parent of of Holland's Schimmelpenninckcigars, strategy,"said Nick Bumbacco, Lane Carolina Group, to develop and sell and producesbulk pipe-tobaccosfor president and c.e.o."Selling the Dr. smokelesstobacco products in the Unit- smoke shops.Lane's Captain Black is Grabow businessis the best fit for Lane ed States.An official launch date has not one of America'sleading pipe-tobacco and Dr. Grabowwhile Lanecontinues to been set,but accordingto a company brands,accounting for I 2.10/o of pipeto- focus on manufacturing and marketing statementit will be "in the not-too-dis- bacco sold in the country. It's followed premium tobaccoproducts." tant future." by Sir Walter Raleigh,with 5.1%. Lane "Re1'noldsmanagement has contin- Separately,Altria Group Inc.'s Philip exports many of its products, with the ued to craft and successfullyimplement Morris USA launchedTaboka, a smoke- leading recipient countriesbeing lapan, a businessmodel focusedon identifica- free,spit-free tobacco pouch product, in Nigeria,Turkey. and Russia. tion with and developmentof its exten- a test market in luly. ReynoldsAmeri- Earlier this year Lane sold its Dr. sivebrand portfolio," said Gore. "Since can'sR.j. Repolds subsidiaryis current- Grabow line of pipes and pipe filters, 2004,they've shown their prowessto ac- ly conductinga two-market test of its and Dill's pipe cleanersto International quire and mergesignificant and relevant own "spitless"smokeless tobacco prod- Pipes& AccessoriesLLC for $4.3 mil- brands,and addingthem to the stableof uct, calledCamel Snus. lion. The saleincludes the transfer of strong category performers, as wit- "There are other companiesinterest- ownershipof the Dr. Grabow manufac- nessedby the Conwood acquisition. ed in the smokelesstobacco category," turing facilityin Sparta,N.C., aswell asa Theseefforts have createdsubstantial said Dianne M. Neal, RAI e.v.p.and

NOVEMBER2006 TOBACCOINTERNATIONAL 19 ,"> COIVIPANYPROFILE

chief financial officer. "The competitive nounced it will voluntarily extend com- defendantstheir requestedappeal of a environment will be what it will be." parableguidelines to all of its brands.Un- lower court's decision,which granted der the agreement,other than in adult- class-actionstatus to the suit. Plaintiffs HAVINGITS DAYS IN COURT only venuesand communications, R.J. are arguing that smokersof so-called In mid-October, R.J.Reynolds and a Relnolds' specialtyblends will not usethe "light" cigaretteswere defraudedinto multi-state group of attorneysgeneral an- name of a fruit, candy,or alcoholicbever- thinking that they were saferthan regu- nounced a collectiveagreement on the age in the future naming of its cigarette lar ones.Should they be allowedto pro- future marketing of specialtyflavored cig- brand sryles. ceed,they are seekingmore than $200 arettesto adult smokers. Most of R.J.Reynolds' specialty fla- billion in damagesto be paid collective- "This agreement codifies R.1. vored cigaretteswere marketed as part ly from the nation's largest cigarette Reynolds'practice for some time of not of the Camel Exotic Blend family of manufacturers.It remains to be seenif using languagedescribing fruit or candy styles,which were originally intro- the positive momentum generatedby flavors in magazineand newspaperad- duced in 1999 as a superpremium- dismissalsin the Price and Engle cases vertising, or point-of-saie communica- priced product. In total, thesestyles will carry into the Schwabcase and de- tions in non-age-restrictedvenues," said representedless than 1/10th of Lo/oof liver a favorabieoutcome for the tobac- L).tt I. Beasley,R.l. Repolds' president the company's annual cigarettevol- co companies. and chief operatingofficer. (In late No- ume. In May, R.]. Reynolds ceased Reyroids American continues to face vember, Beasleyannounced her retire- manufacturing the last three of its re- challenges,some unique to the compa- ment from the company, effectiveJan. 1. maining Camel Exotic BIends. ny, others impacting the entire industry. See"In the Boardroom,"Page 16.) In November, a U.S. federal appel- But the company continuesto show In addition to the conditions of the Iate court granted a permanent stay of considerablestrength, and no matter agreement,which are specificto the com- the proceedingsin the Schwabcase. The what the outcomes,its future will be in- pany's speciaityblends, R.f. Relnolds an- court alsogranted the tobaccocompany @-

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