菲利普莫里斯國際 (PM) 2011 Q1 法說會逐字稿

Good day, and welcome to the Phillip Morris International First Quarter 2011 Earnings Conference Call.

Today's call is scheduled to last about one hour, including remarks by Phillip Morris International Management and the question-and-answer session.

(Operator Instructions) Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community.

I will now turn the call over to Mr.

Nick Rolli, Vice President of Investor Relations and Financial Communications.

Please go ahead, sir.

Welcome, and thank you for joining us.

Earlier today, we issued a news release containing detailed information on our 2011 first quarter results.

You may access the release on our website at www.pmi.com.

During our call today, we will be talking about results for the first quarter 2011 and comparing them with the same period in 2010, unless otherwise stated.

References to PMI volumes or for PMI shipments, industry volume, and market shares are the latest data available from a number of internal and external sources.

Organic volume refers to volume excluding acquisitions, which for this purpose of this presentation also include our business combination with Fortune Tobacco Corporation in the Philippines.

Net revenues exclude excise taxes.

Operating Company income, or OCI, is defined as operating income before general corporate expenses and the amortization of intangibles.

You will find data tables showing how we made adjustments to net revenues and OCI for currency, acquisitions, asset impairment, exit, and other costs, free cash flow calculations, and adjustments to earnings per share, or EPS, as well as reconciliations to US GAAP measures, at the end of today's webcast slides, which are posted on our website.

Today's remarks contain Forward-looking Statements and projections of future results, and I direct your attention to the Forward-Looking and Cautionary Statements Disclosure in today's presentation and News Release for a review of the various factors that could cause actual results to differ materially from projections.

It is now my pleasure to introduce Hermann Waldemer, our Chief Financial Officer.

Hermann?

Welcome, ladies and gentlemen.

We reported a very strong financial performance during the first quarter with, most notably, an increase in our adjusted diluted EPS of 14.4%, excluding currency.

The events in Japan and North Africa, while distressing only resulted in temporary logistical disruptions for our Company and did not have a material financial impact on our overall results in the quarter, thus again emphasizing the advantages of our businesses truly global footprint.

As reflected in early February, our organic volume performance was tampered by anticipated softness in Japan, Mexico, Pakistan, Spain, and Ukraine, as well as by the events in North Africa.

Indeed, these markets collectively suffered a volume erosion of 8.4 billion units, or 18.5%.

All other markets, constituting slightly more than 80% of our volume base, grew their combined volume at the organic rate of 1%.

I am delighted to announce that we are increasing our reported diluted EPS guidance for 2011 by $0.20, to a range of $4.55 to $4.65.

Compared to an adjusted diluted EPS of $3.87 in 2010, this corresponds to an increase of approximately 17.5% to 20% at prevailing exchange rates, and approximately 12.5% to 15%, excluding currency.

$0.10, or half the increased guidance, are attributable to more favorable prevailing exchange rates.

The other $0.10 are attributable to an improved business outlook in several markets, including France, Germany, Indonesia, Japan, Mexico, the Netherlands, and Turkey, partly offset by some additional investments in marketing and sales, and slightly more conservative pricing assumptions.

As you are all aware, Japan Tobacco is facing significant supply disruptions as a result of the tragic events in its home market.

It is our understanding that full supply will gradually be in place within the next few weeks.

We in turn have taken all necessary measures to ensure that we have sufficient end market inventories to supply the market and fill the anticipated temporary vacuum that is likely to occur.

While we have certainly witnessed a moderate lift to our end market sales in the last few weeks, you should know that there are still competitive products available for sale in numerous retail accounts, and accordingly, it is proving difficult to gauge the full extent of the likely uplift in sales.

As retail stocks of our principal competitors products disappear, we will be in a better position to determine such levels.

We anticipate that the second quarter will prove critical in this regard.

It will allow us to have a much better read on total consumption levels, and whether or not and to what extent consumers will return to their prior brand of choice.

At this point, we face significant uncertainty, but rest assured that all actions are in place to optimize our entire supply chain.

We have a positive momentum in the Japanese market, but our share increased by 1.4 points to 25.6% in the first quarter of this year, driven by the success of consumer element innovative Marlboro line extensions.

Our slightly more conservative pricing assumptions are attributable to the continued economic difficulties and consumer affordability issues in such markets as Greece, Spain and Ukraine, and the need to react to certain competitive price moves, such as selective tax absorption, brand repositioning, price discounting, and delays in the implementation of tax-driven price increases.

Pricing will nevertheless remain the key driver of profitability growth of PMI, and our pricing variance in 2011 is expected to surpass the level achieved last year.

Overall, our competitiveness is strong, and our business is in good shape.

This is notably demonstrated by the results during the first quarter results in Asia region.

Volume was up 14% in the quarter, and on an organic basis, it was down just 1.7%.

Marlboro continued to perform strongly in the Asia region, with volume up 0.7% overall and by 5.5%, excluding Japan.

During the first quarter, we achieved volume and share gains in the key markets of Indonesia, Korea, and the Philippines.

In Indonesia, we expect industry volume to grow by around 4% this year, despite the potential unfavorable impact of higher food prices on consumer disposable income.

Our tactical entry last year into the low price segment in certain regions has enabled us to start to grow market share again.

In Korea, we achieved a record market share of 17.8% in the first quarter, with both Marlboro and Parliament driving our success.

In the Philippines, we expect the industry volume this year will be broadly in line with last year, following tax-driven price increases in January this year.

Both Marlboro and Fortune are gaining share in this promising market, and we are making good progress in realizing our planned synergy savings.

Our financial results in the Asia region were excellent, with net revenues up by 11.6%, and adjusted LCI by 34%, both excluding currency and acquisitions.

The other market in the Asia region that has been in the news recently is Australia, where the government has released an exposure draft of its Plain Packaging Bill, which would mandate plain packaging in 2012, and has opened the consultation period on the matter through June 6.

PMI is firmly opposed to such a measure, as there is no credible evidence that it will achieve any reduction in smoking rates, and the government has ignored the fact that it may actually be counter-productive to public health.

Plain packaging will lead to price erosion over time, and will further encourage the growth of illicit trade, which already increased in Australia by over 25% in 2010, according to a recent [deloit] study.

Plain packaging will also result in the illegal confiscation of our trademarks and branded assets, in violation of international trade laws and treaties.

Unlike other governments, which have focused on establishing evidence relevant evidence to demonstrate that plain packaging would have public health benefits, taking into consideration instants such as competition, trade, and legal implication, as well as the likely impact on illicit trade, the Australian government seems to be forging ahead without due consideration of any of these important issues.

PMI will take all measures it deems appropriate, including recourse to the courts if necessary, to oppose the Australian government's proposal.

Our overall performance was also very good in the Latin America and Canada region, despite the significant impact on volume of the disruptively large excess tax increase that occurred in January in Mexico.

Industry volume in Mexico during the first quarter was down by 27%, though the underlying decline is estimated to have been about 14%.

Marlboro and Benson Hedges have remained resilient, with Marlboro reaching a quarterly market share of 50.3%, up 1.6 share points.

Across the region, Marlboro has been performing strongly, with market share gains in all key markets.

On a regional basis, strong pricing felt a 15.7% increase in adjusted OCI and a 1.9 point improvement in adjusted OCI margin, both excluding currency.

While the economies of most emerging markets have now almost fully recovered, those of Southern Europe remain depressed, with unemployment still continuing to climb, most notably in Greece, Portugal and Spain.

Industry volume was down by 25% in the first quarter in Spain, as the situation was exacerbated by the introduction of a total indoor smoking ban, tax-driven price increases, a reduction in trade inventories, and a sharp increase in contraband of a low base.

For the full year, the industry volume in Spain is forecast to decline by around 15% and consumer down trading is expected to continue.

It is worth noting that competitors have introduced or repositioned brands below the [tick-in] level of the minimum excise tax, and have thus not rolled over the full effects of the most recent excise tax increase.

Greece continued to be a drag on PMI results in the first quarter, with the industry volume down 10%, consumer down trading, due to enlarged price gaps, and a difficult comparison, as this market was not impacted by large tax increases, until the second quarter of last year.

While there have been recently structural improvements in the excise tax system, one crucial reform remains to be introduced, an effective minimum excise tax.

In addition, a higher specific to total tax ratio would also benefit government revenues.

Excluding just Spain, industry volume in the EU region in the first quarter was down 2.5%, in line with the longer-term consumption decline trend.

PMI net revenues in the EU region were down 3.5%, and adjusted OCI by 2.3% in the first quarter, both excluding currency.

This was driven by the lower industry volume and the decline of 0.4 share points on a regional basis.

We expect our performance in the EU region to be helped this year by structural excise tax improvements, implemented by governments in France, Greece, the Netherlands, Sweden, and the UK, following the new and improved new excise tax directive that will be enforced through 2018.

In addition, both Germany and the Czech Republic have implemented multi-year excise tax programs, calling for regular, reasonable increases.

The first step in the German tax increase program will take place this May.

PMI has announced a EUR0.20 per pack of 19 cigarettes price increase across its portfolio.

While the [pure pasts on] required is EUR0.04for Marlboro and EUR0.11 for L&M.

This will be a benefit to profitability in the German market, but our decision to eventually follow competitive moves by also offering discounts on large pack sizes, enabled us to regain 0.5 share points in the first quarter to 35.7%, thanks to the continued stellar performance of L&M, and a stable Marlboro share.

In parallel, we increased our share in the important German Fine Cut market by 0.9 points to 14.9%.

In both Italy and France, industry volume was stable in the first quarter.

In Italy, Marlboro has been performing well.

Its quarterly share was down just 0.1%, to 22.5%, and more importantly, its share amongst young adult smokers [or thus] defined as legal age, minimum 18, to 24-year-olds, has been growing again, following the launch of Marlboro Gold Touch, and remains well above its market share.

In France, a slightly improved market share performance has been driven by the continued growth of the premium price for the [modest] brand, whose quarterly share grew a further 0.6 points to 8.2%, and the brand's [yes] share has reached 16%.

More generally, we have witnessed a greater resilience of Marlboro across the EU region, with share of just 0.1 point in the quarter at 17.8%, and notable gains in Belgium, Hungary, the Netherlands, and Poland.

L&M's strong momentum continued with a further 0.2 point share gain to 6.1%, driven not only by Germany, but also by Greece, the Netherlands, Portugal and Sweden.

Our volume in the EMEA region decreased by 0.8%, driven by the continued industry decline and low end share losses in the Ukraine, as well as some temporary logistical disruptions in North Africa, partly offset by favorable comparisons in Romania and Turkey, where there were large excise tax increases in January 2010, but none this year.

Premium brands accounted for more than 40% of our regional volume for the first time since the last quarter of 2008, with increased volumes for both Marlboro and Parliament.

The Russian market was influenced in the first quarter by the impact of rampant food price inflation, resulting from last summer's heat wave and drought, as well as by cigarette price increases.

For the full year, we are forecasting industry volume will decline moderately, and consumer up-trading may be more modest than originally expected.

Our volume declined by 0.8% in the quarter, and at 25.5%, our 2011 quarter one share was up compared with the fourth quarter, but down 0.2 share points year on year.

This was driven by the timing of the implementation of tax-driven price increases, as well as increased price gaps at the bottom of the market.

In Ukraine, we have observed the market contraction and a greater polarization with growth in the Premium and Super Low price segments.

PMI is under-represented in the letter, and consequently, we lost 3.6 share points through the end of February, compared to the same period in 2010.

We have started to address this share issue by strengthening (inaudible).

The Turkish economy has been performing are very strongly.

During the first quarter of this year, industry volume in Turkey was down by a modest 2.1%, compared to last year, when the market was significantly impacted by large tax-driven price increases.

Our volume increased by 10.4%, driven by Parliament, Muratti, and L&M.

Net revenues in adjusted OCI in the EMEA regions were down by 1.7% and 4.4% respectively, both excluding currency.

However, also excluding the tax price windfalls in Q1 2010, adjusted OCI would have grown at the double digit rate.

Our good share momentum continues.

In the first quarter this year, our share in our top 30 OCI markets increased by 0.5 points, to 35.8%.

Our market share momentum is supported by the strong performance of our two key premium brands, Marlboro and Parliament.

Marlboro volume declined by 2.9% in the quarter, driven by the specific issues I mentioned about Japan, Mexico, and Spain.

In all the other markets together, Marlboro volume was up 0.5% in the quarter, and the brand's global market share trend continues to improve.

While many consumer goods sectors are being impacted by significant increases in the cost of raw materials, we are expecting stable US dollar prices for the 2011 tobacco leaf crop, driven mainly by a larger crop in Brazil.

Direct material prices are also stable so far this year, despite higher energy costs.

For the full year, we expect manufacturing costs to increase broadly in line with inflation, partly offset by our $250 million annual productivity and cost reduction targets, which we are fully on track to achieve.

Strong pricing, most notably in Japan, as well as our continued focus on productivity improvements, resulted in an increase of 2.2 points during the first quarter on PMI's adjusted OCI margin, excluding currency and acquisitions.

Our free cash flow increased by 22.6% in the quarter, to $2.2 billion, and by 21.1%, excluding currency, driven by higher net earnings, lower pension contributions, and lower cash exit costs.

We continue to focus on reducing inventory levels, though it should be noted that year-end working capital requirements remain subject to the level of tax price increases, and our success in convincing governments around the world to implement strict [forestalling] regulations.

During the first quarter, we spent some $1.36 billion to repurchase 22.2 million shares, at an average price of $61.21.

We continue to expect to spend about $5 billion in total this year on share repurchases.

In summary, our results this year so far have been very strong, and our business outlook is favorable, though the positive impact of Japan is difficult to measure at this time.

We will increase our investment behind our portfolio of leading brands, and are being slightly more conservative in our pricing assumptions to ensure that we remain competitive in our key markets.

We have raised our 2011 reported diluted EPS guidance by $0.20 to $4.55 to $4.65 to reflect our positive business momentum and more favorable exchange rates, and we will continue to use our strong cash flow to generously reward our shareholders.

Thank you.

I will now be happy to answer your questions.

Operator, can we take questions, please?

Thank you.

We will now conduct the question and answer portion of the conference.

(Operator Instructions) Our first question is coming from Judy Hong with Goldman Sachs.

Thanks.

Hi, Hermann.

Good morning, Judy.

First, in Japan, I think you said total cigarette market was down 16.4% in the first quarter, so it looks like that has come in better than the 20% decline that I think you projected at the outset of the year, and it also implies that March was even better than the run rate in January and February, so have you seen any changes to just the underlying demand decline post the earthquake?

And then what are you assuming for the market decline as a whole for 2011 at this point?

Okay, yes, we had previously assumed an annualized 20% decline, annualized; i.e., October last year to September of this year.

Your number on the year to date, actual 16.4 is correct.

I think we better look at the year to date February number, which is 17.1, 17.5 percentage points down, because there has been already some consumer holding of product in March (inaudible).

But yes, there is of course an improvement overall.

From there on, of course, what is going to be the effect of the tragic event itself, that's very hard to predict, but let's put it this way, we don't see [accreting] in the market.

Okay, and then just in terms of your assumptions that's imbedded in your guidance as it relates to any market share gains that you might experience as a result of Japan tobacco's disruption, at this point, given it's difficult to gauge, are you imbedding any upside in terms of the market share situation in Japan?

Okay, I will give you the elements, but let me say in general first, that of course there are scenarios possible, and we of course did our scenario planning.

We have not taken the most conservative one; we have not taken the most bullish scenario that you could take.

We kind of went into the sound middle ground, and that net-net means that about half of the increased business guidance is attributable to Japan.

Now, let me give you a little bit of the elements there, which go into it, which at the same time make it so hard to give a clear-cut answer, but I will try to do my best to describe the situation.

I mean if year to date share, we set that up 1.4 to 25.6.

In March itself, the share was up 2.9 points to 26.5, so essentially, it looks like we cover more than 60% of JP's temporary losses there.

But now of course, to estimate today what the retention level is going to be that [also] is impossible to predict now, I would say only one thing.

I would expect it to be lower, given the market Japan, given the Japanese consumer, than it would be otherwise in another market somewhere in the world.

And then when it comes to the potential volume benefits of their disruption, well, of course, the first question mark is how long is the disruption going to last, so how many of the SKUs will come, how quickly back into the markets, actually how efficient JP can be with the replenishment of the product pipeline.

Then we have seen, we had mentioned it in the prepared remarks, that yes, there were fairly high stocks out there, higher than what we originally had thought, so consumers were searching for their brand.

So all that comes together, and of course what we made sure of, already in the first effort in March, but mostly now in the second quarter.

Then of course, we have the products available in the Japanese market, but the shipment number that you see is of course only the number essentially driving of course the financials of shipments from our factories to our importer, that is not the number of end market sales or even of consumer uptake.

So all that together, these are the elements, and that gave us the conclusion I mentioned at the very beginning, and that leads to a net result of about half of the increased business guidance is assumed to be attributable to Japan.

Okay, that's helpful.

And then just your commentary about taking a little bit more conservative pricing assumption, and then more investments behind your brands.

Is it a little bit of a different posture, just in terms of the last two or three years where you've really focused more on getting the pricing realization at the expense of volume, and is there a little bit more urgency at this point to make sure that you are getting some of that volume back, or the volume decline to show some moderation in some of these more challenging markets?

No.

I mean, the first and most important point to say here again is that we continue to expect that our pricing variance 2011 is going to exceed the pricing variance of 2010.

Already that, I think, tells you a lot.

Also now, a general approach, where you are normally saying that earnings per share are more important than cigarettes per share for the shareholder, also that conviction has not changed.

The thing simply is, I had been discussing and reporting on skirmishes here and there already in the past, and we see a little more of those selective brand repositionings in other tactical moves, and to those, you simply then have to respond, and you have to protect your competitive position.

I'll give you one example.

Maybe if you look to Russia, where we had announced the price increase in December, we were in the market with new prices in January.

Other competitors have made public their decisions later on, and still today, kind of we see now the last competitor coming into the market with new prices right now in April, after an announcement in January.

This is the type of thing.

All right.

Okay.

Thank you.

You're welcome.

Your next question comes from the line of David Adelman with Morgan Stanley.

Good morning, Hermann.

Good morning, David.

Two things I wanted to ask you.

Two different markets.

First, in Russia, there has been some chatter in the press from different politicians about the prospect of a fairly substantial multi-year excise tax increase in that market.

What's your read on what is really happening and what is likely to happen once you get beyond 2011?

Okay.

Well, the discussion essentially has started for the final tax decisions, for January 2012.

As you know, there is an existing law in place that brings the ad valorem rate as of January 1, 2012 from 7% to 7.5%, and the specific from 280 Rubles 360 Rubles.

There is a 30% increase of the specific component.

And the discussion that was very much in the media was to double the increase of the specific component eventually from 30% to 60%.

So it is the start of a discussion.

Final decisions, I would not expect them before the end of the year, October, probably even November of this year, this is when this will have finalized.

But what you hear there in the press is by no means final.

Okay.

And then Hermann, I wanted to ask you, in Australia, with respect to plain packaging, can you give us some sense of the relative strength of your arguments with respect to expropriation, intellectual property, the confiscation of your business, if they do implement plain packaging in that market, versus the strength or the relative strength of the legal arguments in your defense that you could bring forward in other developed markets, if other markets were to pursue similar types of legislation.

Well, let me describe a little bit the situation there.

I mean for understandable reasons, I would not want to go into the legal strategy here, but I can give the parameters.

So it is not only Australia, it is also the UK that goes through a consultation period right now.

The difference being that in Australia, it is a consultation on a drafts legislation, whereas in the UK, it is on a draft concept.

In Australia, the government appears to be predetermined.

In the UK this all appears to be following a normal regular process.

In terms of now expropriation of trademarks, confiscations of our business, you raise one of the three critical facts that governments must look at, and that also Australia must look at, because there are of course litigation possibilities both under Australian law and under Australia's obligations under international treaties and laws.

So those are the two avenues.

That litigation situation and the legal situation has actually not changed compared to the time when Australia itself, and also the UK before, had been looking at the situation.

And in both cases, both in Australia and the UK, they had come to the conclusion not to implement the measure.

So you would think still that there is no change in facts, there also should be no change in outcome.

So, so much on the background, but please bear with me, it would not be wise to go into a discussion of the legal strategy itself.

Okay.

Thank you very much.

Your next question comes from the line of Jon Fell with Deutsche Bank.

Hi.

I have two things as well.

First of all, a quick one.

Was there any trade loading in Germany in advance of the tax increase for you?

And secondly, you refer to wanting to invest more in your brands and marketing.

Are there any particular regions or countries where you think there is a need to actually spend versus what it is now?

Okay, in Germany, while that remains to be seen, certainly we have seen only now some uptick in consumer purchases, but you referred to trade, well, we will have to see what individual competitors have done; i.e., what their respective stocks of old tax, old price, volumes will be.

That's - - I don't know.

We will have to see what the outcome there is.

But there is nothing that impacted you abnormally in the first quarter?

No, not in the first quarter, no.

Actually, if there is something, it is probably within the second quarter and will have washed out by the end of the second quarter.

Thanks.

And your second question on investments, well, this is very, very specific, and we talk about individual large markets where we see consumer response and real immediate returns.

So it is not just spreading a little bit more money everywhere.

Are there any particular regions where you see those opportunities, or are they really sort of global, but individual as well?

Well, you would look at probably at the Asia and the EMEA region, where there is a bigger growth potential of course.

Okay.

Thanks.

Your next question comes from the line of Christine Farkas with Banc of America Merrill Lynch.

Thank you very much.

Good morning, Hermann.

Good morning, Christine.

My question for you, or two questions for you.

First, you talked about half of the increased business guidance outlook coming from Japan.

I'm wondering if you can elaborate perhaps on where the other half of that business outlook is coming from.

The other half would be a series of markets, some examples here, the first one, Germany, you heard about supplies, you also heard about the improved share performance.

Another one would be Turkey, where Turkey has come fairly quickly out of the crisis they were in last year, a market size decline of 2% only in the first quarter is a good sign.

And our share performance, we are really doing well in the market again, thanks to a complete portfolio, so we are doing pretty well there in terms of shares.

Mexico, well, we had expected quite a market reaction.

If you kind of take out of the 27% decline in that market in the first quarter, if you take out really the trade load (inaudible) effect over year end, and if you take out also additional selling days that you have in this quarter compared to last year, then are you either in the 14% or say in the 13% to 15%, but that's better.

And the second good news in Mexico really is that the Premium segment is holding on very well.

You see the Marlboro share is growing.

Premium is holding on better than the low end, so no down-trading in the market.

That's good news as well.

Indonesia, we are really doing well, share performance, pricing, we have implemented market size growth very nicely.

France, good news on essentially a stable market, and now improved share performance as well.

Holland will be another example of very solid share performance.

So it is a number of places - -

Okay.

So it sounds like rather than just better-than-expected performance in the first quarter, there are some sustainable reasons for your outlook in a number of markets for the rest of the year?

Absolutely.

And my second question really has to do with Romania, just because you called out the market as seeing reduced illicit trade, and I'm wondering how that is being accomplished successfully.

Is that sustainable, and are there other regions that could follow suit?

Yes, situation in terms of illicit trade has improved quite a bit.

This was well above 30%.

I would say this probably has gone down in the range of 10 percentage points.

Well, let's put it this way, it is always a sequence of two things.

First, you need to attract the attention of everyone, including the government, which we did in Romania, which is [valid] in other places as well.

[We'll take] Canada, that was another example, where you first need to get their attention, and then you need the willingness of government really to put enforcement behind, and we have seen that in both countries as well again, both Romania and Canada.

So it is the two elements.

Okay, that's helpful.

And just a quick follow-up on pricing.

You did talk about Russia as an example, where there is some repositioning of competitive brands, and that perhaps might lead to some more conservative pricing on the aggregate, but I'm wondering if it is really quite isolated to Russia or any other markets where you feel this is necessary, rather than a broad statement of product positioning and pricing around the world.

No, it is a little bit more skirmishes, as I said.

It is selective repositionings and other tactics.

Russia was one example.

I'll give you another one.

I mean in Spain, you see there, the minimum tax kick-in is at [three Euro 66], and we have prices in the market at [3 Euro 40], and [3 Euro 75] even, so there is clear absorption of the last tax increase.

So that is just another example.

Or remember the one that we had been discussing earlier, which was the discounting on the big and so-called Maxi-packs in the German market.

So it is here and there.

It is skirmishes here and there.

But again, really look at our first quarter pricing variance, which is very strong, and also at the statement that the sum of the pricing variance in 2011 is going to be greater than the one of 2010.

That's very helpful, Hermann, thank you.

Thank you.

Our next question comes from the line of Chris Growe with Stifel Nicolaus.

Hi, good morning, Hermann.

Hi, good morning, Chris.

Hi.

I had two questions for you to follow-up on Japan.

Not to continue harping on, that but I was just curious, you gave a number at a presentation, I think it was you, about some amount of product you have in market.

I think it was 10 billion sticks sort of in Japan, and I wonder if there was an update to that number?

And I guess what I'm curious about, you have a long lead time to getting product into that market.

Has there been a quicker draw-down because of the consumer response?

Are you able to keep up with the inventory needs in that market?

Yes, we are keeping up the inventory needs.

Yes, I mean our product is coming out of the European factories, you are correct.

By ship, that's a long way, by air freight it's quicker, and we had to take recourse to air freight in order to get some volume in.

And then I wondered if there was any potential to spend a little more heavily in Japan, perhaps to use some of the benefit or windfall, whatever you want to call it, to try and sustain some of this market share?

Is that part of your thinking for the remainder of the year, for what you can do in Japan to potentially hold on to some of this market share?

Yes, but I mean Japan, of course, in terms of spending overall, already before any of that happening is one of our focus markets in there.

As I was just (inaudible) with air freight, there is also of course some additional cost that you simply have, due to the situation, that is distribution and logistical cost.

We will certainly also do everything we can in terms of brand support.

And as we saw our shares are developing very, very nicely.

However, really I think the Japanese situation, with the country in trouble, will lead to a different average behavior of the consumer than it would be the case elsewhere.

So I believe that the retention levels probably will be lower than they would be in another country.

Some of them of course we will be able to retain.

I would think to what extent, that today is just impossible to say.

And I have just one follow-up for you and that is on the Premium segment in general.

In particular, I was looking at Russia, where Marlboro is down, and you clearly outlined a few factors that could be leading to that, as some of your competitors have not passed along some of the price increase.

But just generally across the Premium segment, I saw a good performance overall out of Parliament, the Parliament brand for you, and Marlboro itself, outside of a few troubled markets, it looks like it is doing quite well.

Would you characterize this as being still sort of an uptrading market, you're still seeing that broadly across your business?

Yes, I would say if you're now going beyond Russia, and talking about a world-wide picture, then, yes, since, if you go back to, say, probably the middle of 2008' i.e., before any of the crisis hit, and you compare it to today, then you will have seen a shift from - - a very moderate shift, probably 1% to 2%, from Premium and Mid- to the Low end, not talking worldwide volumes for [our] brands.

But actually if you would like at that more recently, say over the last three to six months, then you would have a slowdown, or even a stoppage of that effect, and I believe we are at the point there now, where with improved economies around the world, our Premium portfolio will serve us very, very well.

It is just [up to us] to look at the markets out there the [other] ones, like in southern Europe, where the situation is still difficult, but overall, I clearly see a return to [upgrading] over time.

Okay.

Thanks so much for your time.

You're welcome.

Your next question comes from the line of Jon Leinster with UBS.

Good morning, guys.

A couple of questions.

Just on the Latin and Canada region, you can give a bit more detail about why profitability is so strong, given that Mexico's volumes are so heavily down.

I presume Mexico is by far your biggest profit center there.

Well, Mexico is a very profitable market, and the price increase has helped, so that is certainly a good part of the reason for the strong performance.

It is not only Mexico.

It is also other profitable markets in that region.

Take Canada, where you had again an increase in the total market size, or you take Argentina, where we continue our stellar performance, and [are now] all of the market share essentially in the range of three quarters of the market.

So there are others, but Mexico is an important one.

So you're saying Mexican profits are well up, despite the volume decline?

Say it again, Mexico?

Mexican profits are still well up despite the volume decline?

Yes, they are, driven by the price increase.

Okay, and getting back to Russia, as you pointed out, the volume declines of Marlboro and L&M are noticeable.

Is that due to the actual segment, the Premium and the Mid-price segments, L&M being down, or is that more a brand specific decline?

And if it is brand specific, particularly for L&M, I mean clearly, you relaunched that a couple of years ago, what is the next step to try and stop Winston?

Well of course, we were referring to delayed increases of tax-driven price increases before, it's always easy to grow share at the lower price.

Going back now to the portfolio itself, to our portfolio, well, in the Premium segment, let me remind you that actually Parliament in Russia is a bigger brand than Marlboro, actually also with much higher margins than Marlboro.

And Parliament is doing very, very well.

Marlboro itself, yes, to be self critical here, yes, we need to do more work on the brand Marlboro in the Russian market, and we have plans in order to strengthen the brand going forward into this year.

From there, you go to Chesterfield, which is a strong higher-end medium price brand, L&M, which had suffered over the last couple of years, that's true, that is not an easy situation.

And then you go to the next one, to Bond Street, where we have had tremendous increases; i.e., we had the best, I would claim, international low price brand in the market.

And then if you go further down, actually as we speak, there is now a lot of price competition going on at the very low end, which is also very low margin.

And at the time with brands like [Java] and others, which are at very low prices.

Well, but it sounds like the decline at those brands, Marlboro and L&M, is brand, rather than sort of segment specific then.

And given you relaunched L&M a couple of years ago is, there anything more that you can do?

Yes, I mean I was mentioning, I was saying that yes, we have to work on L&M to do; we have work on Marlboro to do.

But when it goes to segment, then the story is different.

Overall, in the Premium segment, I was speaking about Parliament, the segment itself, Premium is doing well, and we are having a good share in there.

Medium, including Chesterfield, we are doing well.

And now there is simply intense price competition as well at the very low end, which is chasing market share for not much margin.

Okay.

Thanks so much, guys.

You're welcome.

Your next question comes from the line of Rogerio Fujimori with Credit Suisse.

Hello, Hermann.

Hello Rogerio.

Good morning.

Good morning.

Two quick questions about Australia.

First, [is] your Discount segment is still far more profitable than the Premium segment in your [non-OCD] markets?

And second, could please just remind about the price positioning of [Long Beach] (inaudible) brand there?

First statement, yes, what is called Super Low in Australia is still very, very profitable, that's correct, and it still is the margin of our Premium brand elsewhere.

The positionings of the other brands are Mid-price to Premium price brands, so we are present across the market.

But overall, in the market, yes, there is a certain trend towards the lower end, but as you said yourself at the beginning, this lower end is still a very profitable end.

That's great.

We covered Japan, but could you also talk about the shape of the quarter for the key markets that dragged the group volume performance in the first quarter?

I just wanted to have an idea of the exit rates, to have an idea if things are getting worse, stable, or better, particularly in places like Ukraine and Spain.

Thank you.

Okay.

Concretely now, on the Ukraine, so you want me to comment on the Ukraine, or more on the overall volumes, trends around the world?

What is the question?

Well, it is more particularly on the markets that dragged your performance in the first quarter.

And I think we talked already about Japan, so I think the only ones left are mostly Ukraine, and something on Spain would be appreciated.

Thanks.

Okay.

Absolutely.

Ukraine first then.

I mean on one hand, this is of course a country which has actually very good macro-economic trends right now.

However, when it comes to the cigarette market, then the price increase effects on the market, on the consumer, are simply not over yet.

So I mean, for the price that you buy today, a low price product, you could have bought a bit more than two years ago, you could have bought the Super Premium Parliament brand, so that is really what is happening in the market.

As a consequence of that, you are really see polarization of the market.

You see the Premium segment, almost stable, actually our share up, doing very, very well, but then, in particular in our case, you see a very competitive low price brand, and for us, share losses at the very low price brand, so there is intense competition really at the low end completely polarizing the market in there.

So that is pretty much the situation in the Ukraine.

It will come down, calm down, over time, but it is a difficult situation right now, and there are many price promotions actually in place in that market.

Now, moving over to Spain, well I would say Spain is still very difficult, because there are too many negatives at play for the economy to start with.

We still have a stagnating [GDP].

We still have unemployment at 20%.

Actually, 1.3 million households out of 17.3 million households total in the country, I was told, actually in this 1.3 million households, both partners are unemployed, just to give you an impression of the problem.

So not surprisingly, consumer confidence is low, and the only positive for the economy overall is a recovering tourism.

So in that context, it is not a surprise that the cigarette market is really depressed, not to the level of the 25% that you see in the actual numbers of the first quarter, because there is an important trade stock reduction in there as well, and there is the effect of a total smoking ban and, (inaudible) of January of this year in there as well, so probably 15% is a better number for the full year.

One sentiment also you see in the market now beginning, in particular in the south, we have made a recent study, in three of the southern cities of Sevilla, [Morocco], and Perez, there are almost 25% of the consumption were not Spanish tax-paid products, so that is about double of what it was the year before.

That is just a snapshot, that by no means is it a representative for Spain as a total market.

It has always been higher in the south than anywhere else.

But that is also of course something adding into the problems, and in such a situation, it is not a surprise that you see down-trading in the markets, and even more so of course, the more you go south, the more down-trading that you see.

So that's a bit of the situation on Spain.

Thank you very much, Herman.

Your next question comes from the line of Vivien Azer with Citigroup.

Good morning.

Good morning.

Not to belabor the point, but I wanted to circle back to Russia and in particular, your expectations for excise tax increases as they stand now.

If memory serves, I believe you guys are looking for roughly a 22% increase in 2012, and another 50 basis point increase of 7.5%.

I'm just wondering as it stands today, do you think that is adequately conservative?

I believe it falls notably below the 30% to 40% increase [JT] is looking for.

I would say, I have to say again, I mean have you one fixed point here, which is the existing law.

(Inaudible) 7 to 7.5, specific from [280 to 360].

There was discussion about the doubling of the specific elements, but this is a discussion, and you will hear many more people giving their input in this -- too into this discussion, until the ends of the year.

At this point in time, I feel it is impossible to predict the final outcome.

As I said earlier, I mean don't expect a decision there before October or even November of this year.

We are only in April.

So a lot of water is going to still go down the (inaudible) until we know that.

Fair enough.

The other question that I have on Russia is I guess, given your market share trends this quarter, presumably before the skirmish that's erupted in April from one of your competitors, it seems like there has been a resumption to a certain extent in down trading in the market.

If that's right, that surprises me, given your commentary last month on stabilization, and I know you highlighted a risk that uptrading could be prohibited by price increases, but it still kind of surprises me.

Is there anything else that kind of caught you guys off guard a little bit in terms of the consumer trend?

Because the food inflation, that was almost a year ago, so I'm surprised by the change in tone.

Yes, it is the price increase effect.

I mean as we highlighted earlier, and you mentioned it, there is of course a certain effect in there.

Don't forget that really the recovery of the economy, whilst you see it in the big cities of Russia, it hasn't really reached the countryside yet.

And in that context, the rising food prices are a concern, because those have gone up quite a bit after last year's summer heat and the drought thereafter, and the harvest problems that occurred as a consequence.

So it is those two elements.

Okay.

Fair enough.

My last question has to do with your Marlboro market shares in the EU.

Certainly, I know so many markets make up that whole number, but it strikes me as potentially troubling that you've seen two sequential quarters of market share losses for Marlboro.

I'm just wondering if you could drill down a little bit into how that breaks down between for Marlboro and the line extensions that you've been putting into the market.

Okay.

Let me give you some information then on Marlboro, how it performs in the EU region.

By variance, all those numbers, I wouldn't know by heart, but at the end of the day, they are a part of the Marlboro franchise, and we do those for incremental volumes, but also for the halo effect on the entire brand.

Now, essentially going into it, if you look at the EU, I mean minus 0.1, I think I justifiably call an overall stable performance.

In the EU, albeit, it is true that there are considerable market variations within the EU.

Poland would be an example where the market share of Marlboro is nicely up more than 1 share point to about 10.5% share.

That is clearly uptrading, and that is an effect that we will see also elsewhere.

There is uptrading potential for Marlboro in central Europe, let me call it in general.

Then, I will say you have markets where you have a stable situation, in terms of market share, Germany and Italy.

They will both be down 0.1 to 21.2% and 22.5% respectively.

Then I would say you find other markets where we are continuing to grow, on an already high basis.

That would be Belgium, growing 0.7, to 25.1%, and most importantly Netherlands, it is growing actually again 0.7 to 34.9%.

That's not too bad.

And then you have a large category of markets that we clearly see the effects of a down-trading environment, and that would be Spain, Portugal, and Greece.

Spain, we are down quarter one versus quarter one, down 0.4.

It would be down even more if you compare more recently to Q3 of last year.

Portugal, down 4 percentage points to 18.4%, temporary, again, price cap increases due to delayed implementation of excise tax driven price increases of competitors.

And Greece, again, down-trading environment, the better brand is down 2.4% to 19.3%.

So down-trading environment, stable and growing in a number of them, and uptrading in really more the central European part.

I think that is the categories that you find within the EU region.

Thank you very much.

You're welcome.

Your next question comes from the line of Unidentified Participant.

Hi, Hermann.

Just a quick question regarding the production costs.

You (inaudible) manufacturing cost increase more (inaudible) with the inflation, but if you look at the first quarter numbers, your cost of sales is beyond that 3.3%.

I was just curious to know if there were any specific factors in the first quarter that resulted in a reduction in the cost of sales?

Well, I mean overall inflation, there is a worldwide average, that is something about 2% to 3%.

So that is the range.

But we also, as you know, we have our productivity programs in place.

In terms of major components of our cost of goods sold, that's of course, first of all and most importantly, leaf.

That is about 35% of the cost of goods sold on average is leaf, and on a yearly basis last year that was $3.5 billion.

So within leaf now, you have leaf price increases.

We all remember the situation in 2008, that is absorbed.

That is no longer the problem today.

The leaf price increases for this year that we still expect, will be about two-thirds of what they have been in 2010.

And now they are essentially driven by the currency strength of the underlying Brazilian Real in the leaf price, which then finally is in dollars, of Brazilian leaf.

That's the most important thing.

But against that, go of course, also, our productivity measures, so that is what I can say on leaf.

On direct materials, which is about 25% in there, that is essentially stable, and then of course, you have conversion costs.

There you have [productivity] running against [the same] increases that you of course have to give and give to your work force.

So those are essentially the components.

But overall, I feel pretty good about it, I must say.

But I was just curious about - - if my calculations are correct, that your production costs in the Asia region, declined by 6% so that is actually quite an incredible performance.

I was just wondering if there were any specific [one-time] factors that benefited that.

That is probably - - I must say that must be the effect of the Philippines that are included now.

Yes, that is it.

Of course, if you compare it last year to this year, and now you have all of the Philippines segments in there, which of course on average have a lower cost base than that.

The final question comes from the line of Thomas Russo with Gardner, Russo, Gardner.

Thank you very much.

Good morning.

You had mentioned that you will have synergy savings coming from the Philippines over the year.

Will those be part of the $250 million, or is that on top of the $250 million that you were citing originally?

That's first question, and then, the second question has to do any further color on forestalling, which you mentioned, steps you're taking to store it, but where else are you still seeing that?

Okay.

The productivity and the synergies out of the Philippines is of course part of our total number, because the Philippines are part of our total business.

Second question, forestalling, I mean we have made quite some progress in a number of countries in forestalling, the most effective measure always being the so-called sell-by dates.

Remember two years ago, it must have been that we had really big problems in Poland.

That is solved today.

So it is essentially a one and a half, two months delay only.

So there is simply further room for improvement.

Also, in markets where it is already existing, I was mentioning Russia before, well, that certainly is a country that would be on our priority list.

But you also can always do better in other markets so that it's already in place.

Portugal would be an example for the second category.

Thank you, Hermann.

You're welcome.

That was our final question.

And now I will turn the floor back over to management for any closing remarks.

Well, thank you very much for joining us today.

That concludes our call.

If you have any follow-up questions, please contact the Investor Relations team here in [Luzern], Switzerland, today.

Thank you, and have a great day.

Thank you.

This concludes today's conference call.

You may now disconnect.