Without a doubt, RAI had been riding an impressive performance trajectory recently. Robust savings from merger synergies following Reynolds' union with Brown & Williamson, combined with a new tiered brand portfolio strategy, had lead to strong earnings and improved stock ratings for the leaner, meaner cigarette major. A strategic acquisition of smokeless tobacco maker Conwood in May further positioned the company as a serious contender in the smokeless segment, instantly grabbing market share and gaining a platform to launch its own premium smokeless brands.

In October, quarterly earnings topped analysts’ expectations handily, with the company reporting a 45 percent boost in third quarter profits, earning $309 million, or $1.05 per share, on $2.2 billion in revenue compared to $213 million, or 72 cents per share, earned on $2.1 billion for the same period in 2005. Consensus estimates had been $1.02 per share.

But the quarter was driven primarily by the strength in the company’s smokeless tobacco business and higher-than-anticipated merger related synergies, according to Citigroup tobacco analyst Bonnie Herzog.

In July, second quarter results had looked equally impressive, with RAI’s new strategy helping to drive faster earnings growth and higher margins. Improved pricing, productivity, and strong volume growth helped lift earning, and despite and industry volume decline of 3.3 percent for the quarter, Reynolds American managed to post a 1.2 percent increase. Camel volume, in particular, jumped an impressive 14 percent.

Enter Merchandise Shortages
But in July, a packing-supply problem at Reynolds American’s R.J. Reynolds Tobacco Co. unit crept up and quickly ballooned into a serious merchandise shortage as sporadic, geographically-isolated reports of out-of-stocks - initially limited to the company’s Winston, Kool, and Doral lines - began to spread and grow in frequency, both geographically and throughout the supply chain and to additional brands.

“The issue arose from problems with a packaging-materials supplier not getting materials to us fast enough,” said David Howard, a company spokesman. “We’re working hard to have this problem rectified because we certainly recognize that being out of stock is an unacceptable position for any company.”

The company released several statements directly to the trade updating the situation and attempting to advise when company’s on-hand inventories would return to normal. “As we continue to work through inconsistent product availability issues that are impacting shipments to our wholesale customers,” an August 11 statement declared, “we have remained committed to communicating our progress and time lines for improvement.”

Updates included detailed worksheets broken down by RAI public warehouse groupings and geographic region, providing estimated dates when wholesale inventories would return to “adequate” levels across the entire country in order to properly fill retail orders. Brands experiencing shortages in at least one style included Camel, Carleton, Doral, Gold Coast, and GPC. In an August 11 update, these dates ranged as late as September 25.

“It is also important to note that many brand styles listed on these summaries are at their normal inventory levels today in many parts of the country,” Reynolds stated in the update, “but in low or out-of-stock conditions in others.”

Shortages were also experienced in Reynolds’ private label brands. Retailers and wholesalers of private label brands were advised that specific replenishment plans for these brand would be communicated directly through R.J. Reynolds Tobacco representatives.

Quick Containment HOPES Fade
But by mid-September, Reynolds was acknowledging that the problem was continuing to worsen. In a domino-like effect, shortages had spread to previously unaffected portions of the Reynolds American merchandise line, both in major lines and, to a lesser degree, in secondary brands.

“We are now experiencing out-of-stocks on brand styles that were not issues for us a month ago, in some selected geographies as consumers purchase comparable styles when experiencing out-of-stocks at retail,” Reynolds explained in a September 11 update to trade customers. “For example, we have incurred isolated situations where Winston Lights Soft Pack have become an issue where Winston Lights Box was an out-of-stock and consumers have temporarily transitioned to the soft pack style, driving sales of this style above normal demand. We expect this dynamic to continue over the next couple of months, which means the styles we incur out-of-stocks on will continue to change.”

By September, newspapers were reporting that smokers were scrambling to find some of their favorite Reynolds cigarettes. Cigarette distributors and retailers said that the brands most affected by the shortages have been Monarch, Doral, Salem and Vantage.

According to Howard, the shortage has primarily affected Reynolds’ low-volume brands, which represent a small percentage of its overall production and sales. But he said that there has been a ripple effect on some major brands as customers switched to other Reynolds brands.

“While we have gotten our stock back up on some brands, we’re now out of stock on some of the brands that our customers have been switching to, which we’re working hard to replenish,” Howard told the Winston-Salem Journal.

At the retail level, the product shortages have affected business, as cigarette consumers have either been forced to temporarily change brands or, in the case of extremely brand loyal consumers, search out their brand at other locations.

“We recognize that our out-of-stock issues on selected brand styles have caused a significant degree of frustration for you and your customers,”said Lynn Beasley, R.J. Reynolds’ president and chief operating officer, in a statement. “This is an unacceptable position to be in. Please be assured that we are doing everything possible to correct this situation as quickly as we can.”

By late September, Reynolds had tapped about 80 percent of its production staff for mandatory overtime weekend shifts to work through the backlog and had reached out to additional packaging suppliers for materials.