菲利普莫里斯國際 (PM) 2012 Q2 法說會逐字稿

Good day, and welcome to the Philip Morris International second quarter 2012 earnings conference call.

Today's call is scheduled to last about one hour, including remarks by Philip Morris International management in 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.

Thank you for joining us.

Earlier today, we issued a press release containing detailed information on our 2012 second 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 second quarter 2012 and comparing them with the same period in 2011, unless otherwise stated.

References to volumes are to PMI shipments.

Industry volume and market shares are the latest data available from a number of internal and external sources.

Organic volume refers to the volume excluding acquisitions and net revenues exclude excise taxes.

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

You will find data tables showing 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.

I direct your attention to the forward-looking and cautionary statements disclosure in today's presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements.

It's now my pleasure to introduce Hermann Waldemer, Chief Financial Officer.

Hermann.

Thank you, Nick.

And welcome, ladies and gentlemen.

We, again, achieved strong underlying business results in the second quarter, with actual results impacted by both unfavorable currency movements and the hurdle we faced in Japan due to our extraordinary results there during the second quarter last year.

Our organic cigarette volume in the quarter was down 1.2% to 238.3 billion units.

However, excluding the Japan hurdle of 6.3 billion units, organic cigarette volume was up 1.4%.

In addition, our organic volume of other tobacco products increased by 11.8% in the quarter.

Net revenues and adjusted OCI, excluding currency and acquisitions, were up by 2.9% and 3.5%, respectively.

Without the Japan hurdle, our growth rates would have been in line with our annual mid- to long-term currency neutral targets of 4% to 6% and 6% to 8%, respectively.

Adjusted diluted EPS reached $1.36 in the second quarter, slightly ahead of last year, and were up by 9% excluding the currency.

If one also takes into consideration the previously disclosed Japan hurdle of $0.10 at an EPS level, then adjusted diluted EPS, excluding currency, was up by a very strong 17.7% in the second quarter.

Our results for the first half of the year were excellent.

Organic cigarette volume was up 1.8%.

Excluding currency and acquisitions net revenues and adjusted OCI grew by 6.5% and 8.3%, respectively.

Finally, adjusted diluted EPS increased by 13.3%, excluding currency.

These results confirm our expectations of solid organic cigarette volume growth in 2012.

We have the best geographic footprint in the industry in leadership, in both emerging and developed markets.

Our volume is growing strongly in many markets in both the Asia and EEMA regions, offsetting weaker volume trends in the EU region due to the deterioration of the economic situation and weaker consumer confidence.

Consequently, we expect to continue to grow currency-neutral profitability at a rapid pace with sustained strong pricing and a favorable product mix only partially offset by an unfavorable geographics.

Exchange rates however continue to be volatile.

At prevailing exchange rates the forecast currency headwind this year is slightly higher than the $0.25 per share that we predicted in June; however, our underlying business is very strong and this is expected to offset the additional unfavorable currency impact of $0.02 per share.

We are, therefore, today reaffirming our reported diluted 2012 EPS guidance of $5.10 to $5.20 compared to $4.85 in 2011.

On a currency-neutral basis, our guidance implies a full-cost growth rate of approximately 10% to 12%, compared to adjusted diluted EPS of $4.88 in 2011.

This despite the Japan hurdle and weak industry volume in Europe.

Let me remind you that our mid- to long-term currency-neutral annual growth target for adjusted diluted EPS is also 10% to 12%.

As we indicated during our Investor Day last month, cigarette industry volumes in the EU region were unusually depressed in the second quarter.

The overall decline was 9.7%.

The significant reductions not only in markets such as Greece and Spain, but also in Italy and Poland with even Germany suffering a 5.1% drop.

The decline was driven by a reduction in daily consumption while smoking incidence has remained relatively stable.

For the first half of the year, cigarette industry volume in the EU region was down 5.8%.

This confirms that the second quarter decline was unusually severe as adult smokers adjusted to the renewed recessionary environment and there were some unfavorable timing issues.

Our current expectations for the second half of the year is that the decline rate for cigarette industry volume in the EU region should be similar to that experienced during the first half of the year.

The average unemployment rate across the European Union increased by 0.7 points between June 2011 and May 2012 with significantly more pronounced increases in Greece, Spain, and Italy.

Only Germany showed a meaningful decline.

As a result of the deteriorating job market, the average unemployment level in the EU stood at 10.3% in May.

In Spain and Greece, double this level.

France and Italy are just below the EU average, while Germany and the Netherlands continue to have relatively low levels of unemployment.

We have always highlighted unemployment levels and trends as key indicators for the industry volume.

We, therefore, do not expect the return to the normal underlying decline rate of 2% to 3% in the EU region until the issue is addressed in a meaningful way.

We have achieved a resilient market share performance in the second quarter with 38.5% overall in the EU region, 0.2 points below the previous year's level.

On a half-year basis, our share of 37.9% was down 0.4 points.

We are very encouraged by the performance of Marlboro in this difficult economic environment.

In the second quarter, Marlboro share in the region grew by 0.3 points to 18.4% and it was up slightly on a six-month basis.

Marlboro gained share in the quarter, notably in Belgium, the Czech Republic, Finland, Germany, Greece, Hungary, Italy, and Poland.

It will then continue to grow share in such markets as Finland, Germany, Poland, and Slovakia.

But this was not enough to offset declines in the quarter in Greece, the Netherlands, Portugal, and Spain.

Chesterfield is performing very well and is being successfully established as a strong second leg for us in the low-price segment in the EU region.

We are rapidly gaining share in the growing fine cut category.

Industry volumes increased by nearly 8% in both the second quarter and the first half as adult smokers down traded to less expensive options.

Our share of the fine cut category rose by 1.4 points in the quarter and by 1.7 points in the first half, 14.1% and 14%, respectively.

The market situation in Italy deserves specific attention.

Cigarette industry volume in Italy declined by 10.5% in the second quarter and by 8.5% in the first half of 2012.

The most important single factor has been a reduction in consumer purchasing power, aggravated by the payment of increased property taxes in June and the increase in cigarette prices over the last twelve months.

This unfavorable development in the cigarette industry is not a unique sentiment as a wide range of consumer products have been affected by the economic slowdown.

Impacting specifically the cigarette industry, there has also been down trading to the fine cut category and an increase in illicit trade, particularly the so-called illicit whites, which list brands such as Jin Ling and Classic.

Despite recent price increases, the fine cut category grew by 74.6% in the quarter, though it still represents a relatively modest 6.5% of total tobacco industry volume.

In terms of market share, Marlboro is performing strongly.

It gained 0.3 points to reach a 23% share in the quarter, despite the continued pressure on the premium segment.

However, our overall cigarette market share declined in both the quarter and the first half as the strong performance of Marlboro and the launch of Philip Morris Selection, in the low-price segment, were unable to offset the decline of our local heritage brand, Diana.

In contrast, our share in fine cut grew by 24.5 points in the quarter, to a record level of 31%, firmly establishing us as the category leader in Italy.

In Germany, cigarette industry volume declined in the quarter by 5.1%, this was attributable to the impact of the recent price increases, a decline in consumer confidence in spite of lower unemployment rates.

A difficult comparison with the second quarter last year that was up 4.6% and some timing issues.

We believe that the first half-year decline of 1.3% is a better reflection of the underlying trends.

PMI continued to perform strongly with further share gains in the second quarter.

Our share in cigarettes was up 0.3 points to 36.4%, and our share in fine cut grew by 1.2 points to 16%.

We are very pleased by the improved performance of Marlboro, which gained 0.3 points in the cigarette category and 1.2 points in the fine cut category, while L&M continued to grow share in the cigarette category and Chesterfield gained in both, the cigarette and in the fine cut categories.

As a consequence of the industry volume declines, our second quarter results were soft in the EU region.

Cigarette volume was down 9.4% only partially offset by a strong 18.2% growth in OTP volumes.

Net revenues and adjusted OCI, excluding currency and acquisitions, were down 0.7% and 2.7%, respectively.

We were largely able to offset the lower volumes with higher prices.

Excluding currency and acquisitions, June year-to-date net revenues increased by 2% and adjusted OCI was just above the prior-year level on the same basis.

In contrast, we had another very strong quarter in the EEMA region, and our results year-to-date June were equally excellent.

In the quarter, organic volume grew by 4.9% while net revenues and adjusted OCI, excluding currency and acquisitions, increased by 12.7% and 22.9%, respectively.

While pricing at the $114 million continued to be a significant contributor to the growth in EEMA's OCI, it was almost matched in the quarter by our $104 million volume mix variance.

This is, in fact, the fifth consecutive quarter of positive volume mix in the region.

This was driven by the strength of our brand portfolio with a particularly encouraging performance of our premium brands, with volume up 7.4% in the second quarter.

Overall, nine of our top 10 brands in the EEMA region grew volume in the quarter, with just Chesterfield down.

Marlboro had a strong quarter with a volume gain of over 1 billion units, or 5%, driven mainly by North Africa, Saudi Arabia and Serbia.

The performance of Parliament was truly outstanding.

With volume up 1.1 billion units, or 16.3%, driven mainly by Eastern Europe and Turkey.

On a market basis, our strong results were led by Russia.

But let me provide you with further details on this important market.

Though we do not have definitive data yet, we believe that the Russian cigarette market grew slightly during the first half of the year.

We attribute this to an improvement in the economy and a return of foreign workers as the construction industry has started to pick up again.

As a result of recent price increases in cigarettes, foreseen hikes in utility prices, and a slightly slower expected economic growth in the second half of the year, we forecast that full-year industry cigarette volume should reach a level similar to last year's.

We are outpacing industry volume.

During the second quarter, our volume increased at a much faster rate of 8.7% and was 5% higher in the first half.

Two very important positive aspects of the Russian market were up-trading by adult smokers in spite of significant price increases and our ability to gain market share, thanks to the strength and breadth of our brand portfolio.

For the quarter through the end of May, our market share was 0.7 points higher and 26.1%, thanks to the strong performance of Parliament, L&M and (inaudible).

We took a further price increase of three rubles per pack across our portfolio in July.

We launched Marlboro ClearTaste in Russia in June.

This is a much smoother tasting line of products, which addresses adult smoker preference.

We started the launch in key cities and have already achieved outstanding distribution at point of sale.

Initial consumer feedback (inaudible)data are positive.

It will, of course, take several months before we can draw any firm conclusions.

Our performance in the Asia region was, again, very strong in the second quarter.

This was, however, masked by the aforementioned hurdle in Japan.

Our organic cigarette volume in the quarter was up 7.4%, excluding the Japan hurdle driven primarily by Indonesia, though down 0.7% on a reported basis.

Likewise, excluding the Japan hurdle, adjusted OCI, excluding currency and acquisitions, would have shown a strong increase but it was down 2.6%, including the full comparison for Japan.

Industry volume in Japan increased by nearly 10% in the second quarter compared to the distorted period last year.

For 2012, we are now forecasting a stable total markets though the underlying trend remains a moderate decline of 1% to 2% a year, going forward.

During the first half of this year, Japan tobacco accelerated its program of new launches and this has had some impact on our market share, which reached 27.8% in the second quarter.

This was 0.2 points lower than the previous quarter but still, substantially above the pre-earthquake share levels.

Lark Milds 100s maintained a 0.4% market share and we launched Marlboro Black Menthol Edge 8 and Marlboro Menthol Edge 1 during the second quarter.

Our latest launch this month is Marlboro Ice Blast, 5 milligram and 1 milligram variants.

The 8 milligram variant having achieved a 1.3% market share during the second quarter.

With these efforts and additional new launches in the pipeline, we are confident that we should be able to stabilize our market position going forward.

On the fiscal front, the Japanese government obtained parliamentary approval for a two-step increase in consumption tax, from 5% today, to 8% in 2014, and 10% in 2015.

While prices remain government controlled, the last tax increases resulted in margin enhancing price increases.

Volumes continued to grow in the second quarter in Indonesia, but it is expected at a slower rate than in the first quarter.

Industry volume grew by 6.9% in the second quarter, while PMI volume increased by 17.8%.

Supported by a strong economy, adult smokers have been uptrading to the premium segment, which has grown by 2 points in the first six months of this year.

PMI has the strongest and broadest portfolio in the Indonesian market, along with an unmatched national distribution network and highly qualified and motivated employees.

Our market share grew by 3.1 points in the quarter to 33.5% as Sampoerna A remains the fastest growing brand in terms of share gains, with an increase of 1.2 points to 13.1% and we continue to benefit from rounded price points.

Going forward, we forecast a market growth of around 8% for the full year and look for further PMI share growth, though at a slower pace than in the first half of this year.

Pricing continues to be the most important single driver of PMI's profitability.

The pricing variance was $463 million in the quarter, giving a half-year pricing variance of $832 million.

This year, we have increased prices notably in Argentina, Australia, Brazil, Germany, Indonesia, Italy, Korea, Mexico, the Philippines, Poland, Russia, Saudi Arabia, Spain, and Ukraine.

Our volume mix variance was obviously negative in the quarter due to the Japan hurdle.

However, as can you see on the chart, excluding the hurdle, eight of our top 10 brands grew volume in the first half of the year and the other two were essentially stable.

In volume terms, Marlboro achieved the largest growth, while in percentage terms, Fortune, Sampoerna A, Parliament, and Lark, all recorded double-digit growth.

We are continuing to expand our market share in our top 30 OCI markets.

Our June three-month moving average share of 36.9% is above both our 12-month moving share and the 2011 results, and 1.4 share points above the 2010 share level.

Free cash flow declined in the second quarter by $703 million to $3.2 billion.

Unfavorable currency movements were responsible for over half this decrease.

In addition, we built up finished goods stocks in Brazil and Russia and working capital, consequently, increased by $388 million.

This will be reversed during the third quarter when this inventory is sold.

During the second quarter, we spent a further $1.5 billion to repurchase 17.8 million shares.

In June, the Board approved a new three-year, $18 billion share repurchase program, which will start in August and funds from the previous program will have been fully utilized ahead of schedule.

Our target remains to spend $6 billion on share repurchases this year.

Since the spin through the end of June this year, we spent $24.4 billion to repurchase 449.9 million shares representing 21.3% of our shares outstanding at the time of the spin at an average price of $54.21.

In conclusion, the second quarter of 2012 was, as expected, a very strong one in terms of underlying business momentum but a challenging one in terms of reported results due to the Japan hurdle and unfavorable currency movements.

As we foresaw during our June Investor Day, EEMA and Asia region results were very strong in the second quarter enabling us to offset unusually weak cigarette industry volume in the EU region.

The breadth of our geographic footprint, the continued strong pricing environment based on our superior brand portfolio and productivity gains enabled us to grow both net revenues and adjusted OCI in the second quarter, excluding currency and acquisitions.

Adjusted diluted EPS ex-currency increased by 9% in the second quarter.

If the $0.10 hurdle related to Japan were excluded, the increase in adjusted diluted EPS ex-currency was a very substantial 17.7% confirming the overall strength of our business.

We have reaffirmed today our 2012 reported diluted EPS guidance of $5.10 to $5.20.

Compared to adjusted diluted EPS of $4.88 in 2011, this represents a growth rate of approximately 10% to 12%, excluding currency.

Thank you, I'll be happy to answer your questions now.

Thank you.

We'll now conduct the question-and-answer portion of the conference.

(Operator Instructions) Our first question comes from the line of David Adelman with Morgan Stanley.

Hi, Hermann.

Hi, David.

Two things I wanted to ask you.

First, in the EU, do you think that you can maintain on a local currency basis the overall profitability of the business for the foreseeable future if volume declines persist at these above-trend rates?

Maybe not the rate in the second quarter, but at higher than historical rates of decline?

Well, I would say for this year, I mean, for the second half where we expect a similar decline.

But at the same time, we continue to be cautiously optimistic to achieve low single-digit OCI growth, excluding currency nevertheless.

In the EU region, in years before where we had similar decline rates, we had similar results.

Yes, we see continued market declines there, but they're also talking for this year, also several positives in there.

In Italy, there was still the potential VAT increase looming in September that has been called off, postponed until next year, but who knows what happens until September of 2013, but it's not going to happen this year.

In Spain, the VAT increase of 3% on all goods is being compensated for cigarettes by an ad valorem decrease.

That is good news, too, of course.

And in France, some sort of price increase is going to come in the remainder of the year and despite this economic trouble in the entire region, the Marlboro share is actually up.

Overall, yes, I think, we can do that.

We can still achieve low single-digit OCI growth also in the EU region.

Okay, then the second question, Hermann, can you just update us all on the status of the potential excise tax increase in the Philippines and the potential for fairly substantial duty increase potential in the GCC countries?

Okay.

Philippines first.

The situation there is that the House of Representatives has passed a bill with pretty substantial disruptive excise increases for 2013.

Thereafter even in that bill, the positive is that it takes a multi-year approach.

But that is for now the House of Representatives.

The legislative process is by far not being closed.

After the summer recess, first the Senate is expected to weigh in on the question and then should there be a disagreement between Senate and House of Representatives, then it goes into the so-called bicameral committee.

What I'm telling you here is there is more discussions to come in the third and in the fourth quarter.

Then on GCC, there is a discussion going on.

That discussion we have had many years also, for many years also in the past.

It's still an open question.

I really don't have an update to that one.

It will be seen the remainder of the year.

Okay, thank you.

You're welcome.

Your next question comes from the line of Bonnie Herzog with Wells Fargo.

Good morning.

Just a follow-up on the Philippines.

Thanks for the update on the tax situation, which is helpful.

But could you provide just a little more color on the current market dynamics, just in terms of the market declining there?

What is going on and how you expect this to evolve as the year unfolds and into next year?

First of all, let me start then with the economy.

I see that the economic outlook in the Philippines, which is actually brilliant.

The GDP, the last number I saw I believe that was the quarter one number, up 6.4% with an inflation I think it has been May, a little less than 3%.

Remittances of Filipinos working abroad up substantially in one month and that is about an amount of $1.7 billion coming to the country.

So, therefore, in terms of consumer environment, that is actually pretty good.

That comes late now in a total market, therefore, the full year we would expect a slight growth, so I would say the full-year market about 100 billion cigarettes.

Last year was 97.5 billion roughly.

So, a slight increase therefore in the total market despite the price increase, as you know that was there.

In terms of shares, yes share, we lost a bit of share and we lost that share essentially to some local companies there, which, let me put it this way, sells at surprisingly low prices.

Okay, thanks.

Then just a second question on your B Marlboro campaign.

Could you give us just further details on the rollout and maybe a little more color on just some key markets where this campaign has been having a positive impact on Marlboro?

First of all, it is of course where they started this is in the German market where it has been doing tremendously well, continues to do tremendously well.

It is, as you know, it's the continuation at the end of the day and the translation into modern values of what holds the Marlboro campaign, the cowboy campaign stood for.

It's receiving excellent feedback and continues to receive excellent consumer feedback in the German market.

In adaptations, you will find it in more and more markets around the world.

It is not always going to be exactly the same what you see in Germany, but it's the same idea, the same philosophy behind.

And they will roll it out from there.

It has started in some Latin American markets and it will go further.

It's the new worldwide campaign.

All right, thanks, Hermann.

You're welcome.

Your next question comes from the line of Judy Hong with Goldman Sachs.

Thanks.

Hi, hi, Hermann.

Hi, Judy.

First, in Japan, the consumption tax proposal that you have talked about in Japan, other than the consumption tax increases, are there any discussions of national or regional tax increases that are being discussed at this point?

Not regional, but what will come later in the year is, of course, a discussion on the excise tax outlook.

Typically, as the budgetary year of the government goes from first of April to the end of March, there of course as you perfectly know, these discussions will start in December, make a decision kind of by year-end.

At this point in time, I really couldn't predict the outcome there, but it is obvious and clear that we will be advocating for a multi-year excise tax plan, which would be beneficial for both the government in their quest to maximize revenues and could also be profitable for us at the same time.

Is there anything to glean from the fact that they did approve the other consumption tax increase?

Yes, I would say it is a positive there.

It is a first step into developing an entire refinancing plan if you like for all the funds needed to cope with the cost of the, of the natural disaster of last year.

In that context, the discussions take place.

Consumption tax was of course the key element in there.

Excise tax I believe is going to be a normal discussion.

It will not be dominated by that question.

On the consumption tax, just also to put that a bit into the context, that's something that is going to be manageable for us.

Al this depends, of course, what you assume to be the price level when the consumption tax kicks in at that time, April 2014 and October 2015.

The first increase means a rollover about JPY15 and the second one means a rollover of about JPY10 per pack.

That is manageable, of course.

Right.

Okay.

And you've talked about the market in Japan, the market consumption decline this year being now more stable.

Can you just talk about why, at least this year, the market seems to be doing better than expected?

At the first quarter call, I think I still expected 1% to 2% decline there.

And of course to be honest, it's a hard market to read with all the distortions from last year into this year.

We have to have a prolonged period where smoking incidence has stayed stable.

It has come down a little bit the last two months but not much, so that is why I think that the underlying really is probably a 1% to 2% decline, going forward.

Now I'm talking next years and thereafter.

That is of course eventual pricing.

I'm talking about the underlying trend.

This year, when we take it all together, it will be our best estimate is now that it should be about flat.

Okay.

In terms of your guidance, so, if you look at first half, your adjusted earnings up 13.3%, excluding currency, even with the hurdle that you faced in second quarter from Japan, it sounds like just based on your guidance maybe a little bit of a slowdown in the back half.

I'm just wondering if there are any other factors that makes you think that earnings growth could slow down in the back half?

Are you thinking just in terms of Europe potentially a bit more conservative stance?

I'm just wondering if there is anything to think about in the back half?

No, I mean, there is nothing on the underlying business trends there.

It's simply often a question of comparisons.

If I take the Japan hurdle out, then organic volume in the first half has been growing 3.3%.

And I can't expect 3.3% for the full year and I think nobody does.

Although we are optimistic to achieve our mid- to long-term organic volume growth target of 1% despite the hurdle in Japan.

To give you one example of tough comps, if you go to the EEMA region, then the first half volume results compared to declining trends in the first half of 2011, whilst the second half of the year will compare to already an overall growth rate of 2.4% in the second half of 2011 last year in that region.

So, it's a bit to comps, but underlying, our business is in very good shape and Europe has, of course, been factored in, into our full-year guidance.

Okay.

Thank you.

You're welcome.

Thank you.

Your next question comes from the line of Andrew Kieley with Deutsche Bank.

Hi, good morning, Hermann.

Good morning.

Just going back to Europe and Southern Europe, specifically, could you just talk about if the volume trend in those countries has changed much compared to what you indicated at the Investor Day?

And what gives you confidence that the volume in Southern Europe will have been most -- weakest this quarter and then stabilize more in the second half?

Things have not really changed much compared to the Investor Day projections.

The quarter has come out slightly worse than what we already had highlighted there.

In terms of market sizes, then the best will because of the biggest markets there.

Germany, which has been down in the second quarter by 5.2% is down on a year-to-date basis 1.3%.

I would say in Germany, expect about 1.5% for the full year so the 5% are not representative at all in that sense.

Italy is a complicated market these days and I had it in my prepared remarks.

Austerity measures and consumer confidence going down doesn't make it easier either.

I would say for the full market for Italy I would expect something like 7.5%, maybe 8% decline.

The first quarter was down 6%, the second quarter was down 10.5%.

7.5% to 8% could be a full-year number there in Italy.

Spain, I think the forecast that we had of something in the range of 10% for the full-year outlook is still a reasonable assumption.

It is, of course, was very important that the VAT increase has been offset by reduced ad valorem rates.

And, therefore, in that context I think the minus 10% for Spain is still a realistic number.

If I add in then France, there I would say take out the technical factors and stuff, I think like 3% is probably a realistic assumption for France.

Okay, and then the other question I had is just, your commentary in the guidance, the language about the anticipated business improvement in Asia and EEMA regions.

Does that mean -- it sounds like that's mainly, you're seeing better macro trends in Russia, your growth in Indonesia.

Are there any other specific positives that you're calling out in those two regions?

Well, we just raised our prices by RUB3 in Russia in July.

That plays into that one as well.

And other than that, yes, I mean the overall environment is really good.

The economic environment is the antipode of what you see in the EU region and with the portfolios, the right brands, we are benefiting from those trends in those parts of the world.

Okay, thank you.

You're welcome.

Your next question comes from the line of Chris Growe with Stifel Nicolas.

Hi.

Good morning, Hermann.

Hi, Chris.

I want to ask you two questions, if I could.

The first was a bit of a follow-on to Japan.

It sounds like you're now expecting sort of share stabilization there for the year.

And really just more of a question about why.

That is, do you have less new product activity?

You're seeing a little bit more competitive activity of course out of Japan tobacco?

Maybe it's a combination of factors but I just want to get a little more perspective on your expectation for share in Japan.

We had a very slight loss here.

I mean, we came down from 28% to 27.8%.

That's a slight loss.

We are a competitive people, we don't like that.

But one also has to acknowledge that competitors are not asleep on the switch either.

We have had a very successful launch with Marlboro Black Menthol, as you remember.

JT has come out now also with a successful highly mentholated product that pushed into the market.

That has had some share consequence on us.

But that's the second quarter.

As I've said, we are already out there in July ourselves with new launches, with 5 milligram and 1 milligram versions of Marlboro Ice Blast.

The 8 milligram version is the one that has a 1.3% share which is after such not so a long period in the market, a fantastic share.

The competition will go on and we are never afraid of competition but we take also the other one serious.

That's all there is.

It sounds like it's not a change, though.

So your new product introductions are planned for say the second half of the year though, correct?

We have still more in the pipeline for the second half of the year, of course.

Okay, just wanted to be clear on that.

And then I just had a question for you to follow up on the EU.

Obviously, we had obviously a difficult quarter this quarter and expectation for that to improve a bit from where we were this quarter.

I wanted to be clear in the second quarter, was there any negative effect on volumes from inventory distortions or movements that made this quarter look a little worse than what the underlying results would have shown?

Yes, Germany has been comparing to the second quarter in 2011; that was up by 4.6% and it happens to be that Easter is in the first quarter or in the second quarter from one year to the next.

That is just very, very technical there.

So, yes, there were some inventory movements in there.

And, typically, at quarter ends, you sometimes see intense activity of some competitors with the trade, which we don't do.

Okay.

That is very helpful.

Thank you, and good luck.

Thank you.

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

Hi, Hermann.

Hi, Rogerio.

You flagged the problem of illicit trade in Italy.

Has the problem of illicit trade in Spain gotten worse in Q2?

Illicit trade in Spain should be about 10%, 12% I would assume there, so it's on the increase there as well.

And my second question, Hermann, is whether you give us some color on the phasing of marketing spend?

Should we expect any change to the usual skew towards second half and Q4, in particular?

No.

I wouldn't expect a change in general trends there.

It is really a lot of activities going to the second quarter before the summer break.

And then you have it picking up towards year-end.

That is a very normal pattern which has not changed over the years.

I don't see it change now either.

Great.

And my last question is just any early reading on volume trends in Brazil?

For the tax-driven price increase and the minimum price?

Sorry, Brazilian effect?

That is correct.

Brazil, okay.

In Brazil, you of course have now the pricing is implemented, the tax increase was May 1, all of the prices are there.

We do see an adherence of local manufacturers to the new minimum price of BRL3 there but as the minimum price is still relatively low, I think the real effect will only come with the already scheduled and foreseen minimum price increases over the years.

We don't see, however, really, an improvement on the illicit product flowing in from Paraguay into Brazil.

Thank you very much, Hermann.

Okay.

Your next question comes from Thilo Wrede with Jefferies.

Good morning, Hermann.

I would have expected L&M to do a little bit better in the EU given that there's probably down-trading going on.

What am I missing there?

Well sometimes you can't have it all; Marlboro is doing better.

I think the two are a bit linked, no?

Seriously, L&M there is nothing at all.

The brand is going well.

In Germany, the growth is still growing, but it has slowed down a little bit, but that is fine with me.

We recuperated with Marlboro.

And then when you go over to Spain, well in Spain, the declines there in Spain are actually linked to brands that absorb part of the minimum tax today there.

I'm talking about brands that sell at less than EUR3.55.

This is today the kick-in of minimum tax.

That kick-in actually is going to EUR3.77 on September 1. So I look forward to that date.

Okay.

And then in Japan, at what point do you think the innovation disadvantage relative to JT right now, at what point will that start to fade?

I would say I trust that (inaudible) to have had a real hit with the highly mentholated product that has come out under Mile Seven.

We have had a series of very good ones, too.

We will keep on working on our new launches and being competitive in the market.

A one-time hit does not change our plan.

Okay.

The last question I had for you, with illicit trade picking up again in Canada, is that a cautionary tale that maybe is sustainable?

Fighting off illicit trade is much harder than some short-term successes might imply?

Honestly, to the contrary, you might certainly (inaudible) thereafter to the contrary.

I have big hopes that illicit trade will come further down in Canada because the province of Ontario has declared that they are essentially copying the measures that the province of Quebec had implemented, was it now two years ago, which have brought quite a bit of volume back into the legal, paying market.

So as the enforcement in Ontario kicks in and the total illicit trade in Ontario is estimated to be about 4 billion cigarettes.

So quite a bit of that could come through and the legal market could benefit from that.

Honestly, I would expect the opposite going forward in Canada.

Okay, great.

Thank you, Hermann.

All the best.

Thank you.

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

Hi, good morning.

My first question has to do with the launch of the new Marlboro line in Russia.

You guys posted volume growth on the Marlboro brand in that market for the first time in a number of quarters.

I am curious if you could give us a sense of how much of that growth was from the sell-in of the new products versus any kind of underlying benefit to organic volumes from Marlboro.

In the second quarter on Marlboro ClearTaste, that is of course now we talk shipment numbers, we don't talk Nielsen number; we talk shipment numbers.

There's still of course a pipeline in effect bringing the product to the distributor and from there into wholesale and retail trade.

The total volume increase in the EEMA region in the quarter was 3.8 billion cigarettes.

Out of that, roughly 10% has been Marlboro ClearTaste.

So yes, it's there.

It's some pipeline in effect, but it's just 10% of the overall growth.

Understood.

My next question again on EEMA has to do with Turkey.

At your Analyst Day, you highlighted some early successes in reductions in the illicit trade and it sounds like that was again a benefit onto the Turkish market in the quarter.

Given the acceleration you have seen there, I think, 4.5% roughly year-to-date volume growth for the industry.

Do you have a sense of how much volume is coming back into that market?

Our latest estimate is that illicit trade has come down by about 3 percentage points national average from 20% actually to 17%.

That's our latest estimate; these are of course by definition always estimates.

So the 4% growth that you quoted, that is actually a good estimate for the full year.

So I would expect the total market to be in the range of 95 billion cigarettes.

Wonderful.

And my last question has to do with Spain.

I hate to split hairs here, Hermann, but as I think about your outlook for the full year of 10% in line with year-to-date and I look at the comps that you face, I think it implies some kind of improvement in the back half of the year because one half of 2011, the market was down 19% and then you finished the year down 17%.

Is it the VAT change or is there something else that gets you on the margin incrementally more positive that despite a tougher comp you can maintain the trend?

[When there's a market to effect it at play] here there were the price increases that we have seen, several ones, as you remember.

There is now -- there hasn't been a price increase now for awhile and the VAT threat has been avoided.

In terms of comparisons, it was also a question of how much volume is in retail trade.

So at the end of the day, that is the best estimate we have coming out of the Spanish market.

Can it be 11%, can it be 12%?

It could, but we talk something around 10% for the full year.

Understood.

Thank you very much.

You're welcome.

Your next question comes from the line of Erik Bloomquist with Berenberg Bank.

Hello, Hermann.

Erik, hello.

I would like to ask about the plain packaging and I'm wondering if there is a difference in the WTO challenge having the Dominican Republic file a complaint?

Does this mean that there is more momentum in the formal adjudication panel?

And then secondly, is there any read-through from that to what may happen in the UK with the consultation underway and then perhaps as the result, sometime toward the end of this year, beginning of next year?

Okay, on plain packaging, you have actually mentioned two of the three developments in that area.

The WTO claim of the DR that has now officially filed a Request for Consultation of Australia, actually, I believe yesterday, or the day before yesterday.

That adds another country and it adds more clout and pressure into the procedure.

We continue to be optimistic that more countries will actually follow that example.

So that puts simply more weight into the WTO claims between those governments.

On the UK, the extension of the consultation period by another month now to mid-August, because that was supposed to end mid-July.

It's simply driven that a lot of people have made submissions and continue to make submissions to the government.

I take it as a sign that the government is serious about their evaluation effort in that process.

If that is all happening on a rational basis, and I continue to think that this is the case, then I would also expect that the UK government comes to the same rational conclusion as they came 2.5 years ago in not to implement.

The third new element, the new one is actually under the Bilateral Investment Treaty Claim that Philip Morris has, the first procedural hearing is actually now scheduled for July 30 in Singapore.

Super.

Thank you.

You're welcome.

Coming back to the Turkish market, could you update us on the outlook for any tax increases at the end of this year, beginning of next year?

Are they thinking about raising the ad valorem again or is that somewhat off the table?

Okay.

Remember when we were here at the first quarter call, there we had had the press statement of the Finance Minister and the Deputy Prime Minister that they will address the excise tax structure.

That has happened.

The Council of Ministers has authorized specific tax to be implemented to an amount of up to 20% of the minimum excise tax.

The timing and the actual percentage and amounts, that is still to be defined.

But I would expect it still this year.

So I think that is a positive development and a sign of rationality in the whole process.

Super.

Thank you.

Thank you.

Your next question comes from the line of Ann Gurkin with Davenport.

Hi, Hermann.

Hi, Ann.

I was wondering if you could just help me with the Marlboro brand franchise.

We saw volumes slow sequentially from Q1 to Q2 and we saw good share growth continue in Q2.

But how should I think about that franchise in the second half, the impact of markets, pricing, innovation?

Can you just help me think about volume and share progression as the year unfolds?

First of all, really not even the quarter if I go to year-to-date.

Yes, for Asia, I have to take the hurdle out.

But excluding the hurdle in Asia, Marlboro is up 0.2% to 6.2% and that is all year-to-date June numbers.

In the EU is up 0.3% to 18.4%.

In EEMA it's up 0.1% to 6.9% despite still measured by Nielsen declines in Russia.

Less in America, up 0.4% to 14.2%.

So, yes, it's growing.

It is also growing in terms of shipments.

Even year-to-date including the hurdle, it's up 1.7%, excluding the hurdle, it is up 2.9%.

If I then move over really to the big markets where it's really substantially up, then you have there first of all, I would think of Mexico.

It's growing now in the quarter, 1.2 percentage points to 53.2% and the brand is in terrific shape there.

It's growing by 0.9% in Poland.

In Poland, you see [a sentiment] that the top 10 brands really capture more and more of the market volume and you see a consolidation into fewer brands.

That is clear uptrading potential for us and for our Marlboro and also L&M there.

Germany, we talked about earlier on the call.

Italy is growing despite the recessional environment and 0.3 percentage points to 4.5% in Indonesia.

Given the size of the Indonesian market it's quite some volume.

When you go to those markets where Marlboro is actually down then there are very specific reasons in there, understandable reasons, which are not there to be forever.

Korea, it's down 0.9% to 7.7%, while that is clearly driven by our price increases that we implemented.

And we compare still to the periods where we had a price advantage versus international competitors and we are at par with the Korean competitor.

In France, it's down 0.8% in the quarter to 25.2%, very simply driven by the fact that Marlboro is the only big brand who is retailing at above EUR6 where a lot of brands retail below EUR6.

As I mentioned earlier, there is a price increase coming up in France.

And in Spain, the decline here well, in such a recessional environment, what else could we expect?

But take it all together, driven by the innovation, driven by new campaigns, driven by better execution on the marketing and sales level, i.e., our new commercial approach, Marlboro is doing well.

Pockets of weakness like Russia exist and we work on those.

I'm very positive on Marlboro overall.

That's tracking where you all would expect for the year.

Is that fair?

Say that again, I could not hear.

Is it tracking in line with expectations for the year, Marlboro overall for the first half?

Absolutely.

Yes.

Great.

Best of luck to you Hermann.

Thank you.

Thank you.

Your next question comes from the line of Christ Ferrara with Bank of America.

Thanks, Hermann.

Just one last clarification on the EU.

Not to beat this thing to death, but it does sounds like you're indicating broadly across the segment that the first-half volume numbers may be a better indicator of what the go-forward looks like than are the Q2 numbers, even though it looks like things have continued to worsen, especially from a macro perspective and the number was a little worse than you even thought a month ago.

So can you give a little bit more color on what the inventory/timing piece of the EU is that will cause Q3 and Q4 to get better than Q2?

I'm just trying to understand why we would think that first-half number is a better indicator than the more recent Q2 number?

Thank you very much.

There is many markets in there and, as I said earlier, Germany is just the most flagrant example there.

You had the Q2 down by 5.2%, whereas year-to-date is down by 1.3% and our full-year estimate for the German market is down 1.5%.

So, you have this technical reason in the second quarter where in Q2 2011, you compare to an up of 4.6%, these are comps.

Let's not get hung up too much really on quarters.

Year-to-date trends are the more reliable indicator.

I'm not talking it rosy here.

Yes, the EU region is not easy, but there is no reason to believe that the EU region is now going to be down 10% for the rest of the year.

It's not going to be down 10% for the year; it's going to be down in the range where the year-to-date is which is anything around 6%.

Thank you.

You're welcome.

Your next question comes from the line of Michael Avery with CLSA.

Hi, Hermann.

Hi, Michael.

One quick question.

You had said your estimate for the increase in leaf cost was around 2% for 2012.

Has that changed at all with the drought in the US?

Is there upward pressure on that?

No, what we see there really is about 2%, 2.5% -- 2.5% I think is the most realistic number of the kilo prices going up from the drought in the US.

This is a worldwide business.

One individual geography does not change total trends, maybe marginally, but not substantially.

Okay.

You had cited Thailand and Vietnam as a couple of the drivers for growth in Asia.

Those are obviously relatively small markets for you but can you give a little color on what is going there?

Were they up quite a lot to be worth mentioning?

What sort of growth are you seeing there?

Vietnam, remember we have restructured a bit our business setup there last year which has given us a better influence on marketing and sales of our products.

We are actually from a very low base, almost doubling our volumes in that market, but admittedly from a low base.

We concentrate on the five or six big cities.

The best example that highlights the future growth potential is actually that in the city of Hanoi we now have a market share of about 15%.

There is plenty of possibility going forward.

Thailand is a bit more volatile environment where we are up against a well-protected Thai monopoly but we have good brands there but it's a bit more complicated there, I would say.

That is helpful.

Thanks.

And lastly just in Indonesia, obviously the volume growth there is very strong.

What kind of pricing gain did you see in the quarter?

In Indonesia, the way we implement pricing in Indonesia is actually that we increase several times over the year.

It can be anything between five to eight times on average per year.

Our trading price is into the wholesale price so it's not like in many other places where you have whatever an excise increase and the morning thereafter all the prices change.

So Indonesia has constant pricing throughout the year.

So that just continued like normally --?

Yes.

There's nothing particular there.

That is helpful.

Thanks and congratulations.

Thank you very much.

Your next question comes from the line of David Hayes from Nomura.

Morning, gentlemen.

Two if I can.

Just getting back to the guidance not changing, obviously, as you make the point, the EU is a little bit worse since we saw you in June.

The currency obviously got a little bit worse as well.

Can you just be a little bit more specific about which markets have got better over the last four to six weeks that leave you confident that you're still in that range?

Or was there a little bit of comfort baked into the previous guidance and you're just not through that level yet?

And then secondly, just following-up on that Indonesian point, clearly that has been a huge success for you both in terms of the market, but your market share performance.

Are you seeing anything from competitors in terms of trying to arrest that market share momentum that you're seeing, or would you be confident that that will continue given what you are doing there through the second half in terms of market share?

Thanks you very much.

Let me start with Indonesia.

As I said, (inaudible) before.

Nobody can expect continued share growth in the range of 3 percentage points.

All the way along we have said that this is going to slow down a bit.

But that being said, I am just convinced that we have the best Company there, we have the best brands, we have great management, we have great employees, we have great distribution.

We're just doing extremely well.

Overall, the pricing environment is rational, the government, yes, is increasing excise taxes every year, but has not done that for years in a disruptive manner.

So the elements are all there for a very positive performance to continue in the Indonesian market.

And then to your first question on the overall guidance, let me answer that way.

We are all very pleased to see that our Asian growth engine is now complemented by a very strong performance also in Eastern Europe.

Is that Russia?

It felt like in the presentation, in the release that maybe Russian trends were stepping up a little bit the last, I guess your performance within that, with the investment behind Marlboro.

Is that one of the key markets to your point that's kind of got better than you were hoping for the last couple of months?

Russia, by its sheer size of course is the most important market in the EEMA region.

But there is also Turkey, there is also Ukraine, there is Kazakhstan, there is North Africa, there is the GCC countries, which are also very prosperous countries, with growing population and growing purchasing power.

So there are many places in that region.

Of course Russia is the most important, but there are many others.

Thank you so much and enjoy the extra time you have got.

Thank you very much.

Your next question comes from the line of Karen Lamark with Federated Investors.

Good morning, I just wanted to go back to the EU and ask you to comment on how you see the balance of volume and pricing in light of the apparent increase in price elasticity and the illicit trade.

And really what I'm trying to get at is whether or not these conditions and competitive dynamics might warrant a change in thinking about pricing, particularly if macro pressures seem, as they do, seem likely to persist.

Thanks.

Honestly, I don't think so because when it comes to pricing, the first thing you need to think about is excise tax.

And governments all across Europe have been rational.

I think there can't be a more convincing example of the very recent one in Spain that disruptive measures do not maximize excise revenues, but regular, moderate steps maximize excise revenues.

And that is, at the same time, the best not only for the governments, but also the best for industry competitors like ours.

So I do not see a change in the rational environment.

You have seen a continuation of that rational environment if you look back over the last two years.

The European crisis is already going on for a little longer than the last six months.

And I see no sign why that all of a sudden would turn and change into an unreasonable environment.

I can't see that.

Thank you.

You're welcome.

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

Hermann, I am delighted to ask the last question of you --.

Hi, Tom.

In this role.

Congratulations, and good luck.

My two quick questions, can you spend a second talking about the role of Lark in Japan?

It seems like the brand that's been most impacted by the Japan hurdle and tell us about the strength of Lark and the innovation applied to Lark in Japan.

And then the second question was just to look for an update, any kind of narrative on the next generation of products that you tipped us to recently and whether there has been anything newsworthy.

Okay.

On Lark in Japan, let me put it this way.

Lark is more of a traditional brand, more of a Japanese brand, as funny as that might sound.

But it's probably a little bit more vulnerable than a truly international brand like Marlboro is.

That is why successful launches of competitors as the one I was quoting probably is putting more of a dent into a Lark than it eventually could put into a Marlboro.

That being said, it has been a big growth driver last year.

So, everything has two sides?

Yes.

So we did have a lot of additional smokers into Lark during the special situation, the crisis of last year.

In terms of NGPs, there is really nothing new to report compared to our presentations that we had at our Investor Day only a month ago.

Thank you very much.

Best wishes.

Thank you.

That was our final question.

I would now like to turn the floor back over to management for any closing remarks.

Okay.

I would like to close with some personal remarks here.

It was an exciting journey over the last five years which started with preparing the spinoff itself and then life as an independent Company quoted at the stock exchange.

It has been a wonderful period of my life.

It was a great pleasure for me to work with you all and, more importantly, to get to know you, the analysts following our Company and many of our investors.

Let me thank you for your confidence and trust over these years.

I will certainly remain a shareholder of PMI because it is simply a superb company and I hope to get a chance to see you again in the future.

Thank you, and all the best to all of you.

Hermann, thank you very much.

Let me add my personal congratulations and best wishes to you.

Certainly on behalf of the Investor Relations team, we appreciated everything you did for us; your support, your commitment, your wisdom, your friendship and we wish you nothing but the best in your retirement.

Congratulations and thank you.

And with that we will thank you all for joining the call as well.

That concludes our call.

If you have any follow-up questions, you can contact the PMI Investor Relations team in Lausanne.

Thank you, have a great day.

Operator.

Thank you, this concludes today's conference call.

You may now disconnect.