Reynolds American Inc. has touted for years its desire to be the tobacco industry's trailblazer for innovative mainstream smokeless products.

The importance — and priority — Reynolds places on that role was evident once again as the company released its second-quarter earnings report Tuesday.

Daniel Delen, the company's chief executive and president, provided an innovation update to analysts before discussing a 35 percent increase in net income to $443 million.

Although Delen provided limited details, citing competitive reasons, he said Reynolds is preparing within the next six months to carve paths in several categories, including vapor (likely electronic cigarettes), nicotine-replacement therapy (NRT) and nicotine extract products such as lozenges.

Reynolds also is preparing to launch new styles of heated cigarettes similar to Eclipse, which it introduced in 1996 and still sells upon request to wholesalers and retailers.

According to Pat Shehan, owner of the Tarheel Tobacco retail-shop chain, Reynolds is introducing in limited "lead markets" an electronic cigarette branded as Vuse and smokeless pouches and pellets branded as Viceroy.

Reynolds spokesman David Howard said the company "is not in a position to comment on specific brand names or retail locations at this time as things are still a work in progress."

Shehan said those products are available in his stores at 6311 Stadium Drive in Clemmons, 3193 Peters Creek Parkway in Winston-Salem and in Danville, Va.

A PowerPoint presentation describes Vuse as a "single, ready-to-go digital vapor cigarette with no charging or assembly required."

"Since they've asked me to not display the new products, most of the sales have come to Reynolds employees," Shehan said, noting that even though the products are not on display, they can be sold to customers who ask for them. "But the news of the products is out there."

Focus on conversion

Although Delen acknowledged Tuesday that there's growing consumer interest in e-cigs, "what we see is very high levels of trial and relatively low levels of conversion."

He said that indicates to Reynolds that adequate e-cigarette products "have not actually been deployed in the category yet. So that's really where a lot of our focus and efforts are our focused."

Delen said new smokeless products are the latest step of Reynolds' evolution into what it is calling "a total tobacco company."

"We're 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," Delen said.

Those products include Camel Crush menthol-capsule cigarettes; Camel Snus, a moist snuff product; and dissolvable Camel chew sticks, orbs and film strips for the tongue.

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

"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."

Reynolds' first publicly acknowledged launch is an NRT gum made by its Niconovum pharmaceutical subsidiary, which represents its first product introduction in the United States. Reynolds bought Niconovum AB in 2009. Its products previously have been sold in Denmark and Sweden.

The gum will be sold in what Reynolds is calling a "lead market" in Des Moines, Iowa, during the third quarter under Niconovum's Zonnic brand. Although Reynolds has not said how many pieces will be in a pack of Zonnic gum, Delen said it will be priced in line with premium cigarettes at a range of $4.50 to $7 a pack.

Bonnie Herzog, an analyst with Wells Fargo Securities, said Reynolds' ability to commercialize innovative products shouldn't be discounted. "It is one of its leading competitive advantages to deliver shareholder value over the long term," she said.

Eyes on the future

Although Reynolds and other tobacco manufacturers cannot describe their smokeless products as reduced risk compared with cigarettes — they need the Food and Drug Administration's approval to do that — it is clear they are key to Reynolds' future.

The FDA was given oversight over most tobacco products by Congress in 2009.

However, it has not set standards for tobacco product introductions. Most smokeless products carry a warning label that includes "this is not a safe alternative to cigarettes."

Most anti-tobacco advocacy groups are scrutinizing smokeless innovations to determine whether they could serve a public-health benefit or work as gateway products to cigarettes, particularly for youths.

Analysts question the level of demand for heated cigarettes, which work this way: Smokers light a carbon tip that heats air that, as it is inhaled, passes over tobacco in a cylinder that's identical to a standard cigarette. The flavors of tobacco and nicotine are inhaled and then exhaled by smokers.

By comparison, a nicotine-extract product is smokeless and contains nicotine, but no actual tobacco. Howard said the company is exploring options for those products.

In May, Altria Group Inc. began testing in Virginia a nicotine-extract product called Verve.

It is a lozenge-shaped disc made of cellulose fibers and polymer and does not dissolve. It works by releasing nicotine over a 15-minute period as the user sucks or chews on it. Altria said each disc contains about 1.5 milligrams of nicotine, less than in many smokeless products. The closest Sheetz stores to the Triad selling the product are in Danville, Roanoke and Wytheville.

Reynolds appears committed to developing its smokeless products internally rather than just buying the expertise of other companies as they did with moist snuff (Conwood, now American Snuff Co. LLC), additive-free cigarettes (Santa Fe Natural Tobacco Co. Inc.) and NRT products (Niconovum).

"I think we have a good organic development program within our research and development," Delen said. "But of course, we also look externally, and I think all those options are open to us."

Another key aspect of smokeless innovations is it could help Reynolds re-enter the international marketplace that it largely departed after selling the rights to its cigarette brands for $8 billion to Japan Tobacco Inc. in 1999.

Delen said Reynolds is considering international partnerships.

"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," Delen said.

E-cigs show potential

Reynolds has perhaps its best revenue opportunity with electronic cigarettes, or e-cigs for short.

E-cigs are battery-powered devices that heat a liquid nicotine solution in a disposable cartridge and create a vapor that is inhaled. Refill cartridges can be purchased in different amounts and flavors; five-packs typically cost between $9 and $18.

By comparison, a carton of cigarettes can cost between $25 and $50 for most name brands.

"We think e-cigs are to tobacco what energy drinks are to beverages," Herzog said. There are projections of $1 billion in annual sales within a few years, Herzog said, in part because there currently are no federal or state excise taxes on the products.

"E-cigs are profitable, growing quickly, gaining shelf space and consumer acceptance; therefore e-cigs are an important new niche category for retailers," she said.

The main sales challenge for e-cigs has been reputational, as in there had been no major tobacco manufacturers selling the products.

Many consumers have shied away out of safety concerns since most e-cigs are made in China. E-cigs also have drawn opposition from federal and state health officials, including North Carolina, because of where most are made and there is limited regulatory oversight of their contents.

That drawback was removed partially in April when Lorillard Inc. bought blu Cigs, based in Charlotte, for $135 million. Herzog said a survey of tobacco retailers and wholesalers found "several respondents noted Lorillard's purchase of blu Cigs lending credibility and legitimacy to the entire category."

There also are royalty issues with a Chinese company to address, analysts said.

Herzog expects Reynolds "to be the next mover into this growing category, most likely organically, but we wouldn't rule out a potential acquisition." She said potential targets are NJoy and 21st Century. Howard said it is Reynolds policy "to not comment on any rumors or speculation regarding any possible acquisitions."

Bill Godshall, executive director of SmokeFree Pennsylvania, said he expects Altria, Reynolds and other companies will go big with e-cigs.

"They already have contracts with 500,000 retailers, ensuring highly desirable shelf displays and many other competitive advantages," Godshall said.

Delen acknowledge smokeless products are facing a display challenge.

"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," Delen said.

"Some of the more progressive thinking I've seen out there is to actually create a home for all these alternative tobacco products."

Jeff Lenard, communications director for the National Association of Convenience Stores, said more stores are dedicating more space to smokeless products.

"You're seeing more smokeless products sold in convenience stores because there is more demand for it, largely because of the stigma attached to cigarettes or requirements where you can't smoke in certain places," Lenard said.

"It is an evolving display landscape, much like you have seen with energy beverages. It's still not clear who buys these smokeless products, and what the potential liability is.

"There is some trial and error with retailers seeing what works best for their stores, but I expect you will see something more standardized over time," Lenard said.

Brad Rodu, a professor of medicine at the University of Louisville and a smokeless-tobacco advocate, said he believes "tobacco manufacturers have an obligation to smokers to develop, manufacture and sell these vastly safer cigarette substitutes."

John Spangler, a professor of family and community medicine at Wake Forest School of Medicine, supports developing and marketing products that lessen exposure to tobacco.

"I would be concerned about the heat-not-burn product because many of the carcinogens in tobacco are volatile and would vaporize, and thus be inhaled, when heated," Spangler said. "I would not recommend that product."

Spangler said many of his patients are trying e-cigs as a cessation product with some success.

"I cannot fully recommend it because I cannot vouch for the purity or potency of the nicotine in the liquid," Spangler said. "I tell my patients the potential risks and benefits of the e-cigarette and let them make the decision."

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