菲利普莫里斯國際 (PM) 2012 Q4 法說會逐字稿

Good day, and welcome to the Philip Morris International fourth quarter 2012 year-end earnings conference call.

Today's call is scheduled to last about one hour including remarks by Philip 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.

Thank you for joining us.

Earlier today we issued a presses release containing detailed information on our 2012 fourth quarter and full year 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 Fourth Quarter and full year 2012 and comparing them to the same periods 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 volume excluding acquisitions.

Net revenues exclude excise taxes.

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

You'll 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 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 Louis Camilleri, our Chairman and Chief Executive Officer; and Jacek Olczak, our Chief Financial Officer, who will join Louis for the question-and-answer period.

Louis?

Thank you, Nick, and good afternoon, ladies and gentlemen.

As expected, we finished 2012 on a very strong note with fourth quarter organic cigarette volume growth of 2.9%, net revenues and adjusted operating companies income or OCI, both excluding currency and acquisitions increasing by 6.4% and 12.3% respectively, and adjusted diluted earnings per share growing by 16.4% excluding currency.

Our strong volume performance was partially flattened by some favorable inventory movements which we estimate added some 60 basis points to our 2.9% growth rate.

Cigarette volumes for the full year reached 927 billion units, an increase of 1.3% on an organic basis.

The solid performance reflects the breadth of our geographic coverage, our excellent balance between emerging and developed Markets and our superior brand portfolio.

The key volume drivers were the EMA and Asia regions where we realized organic volume growth of 4.6% and 4.2% respectively which more than offset a 13.5 billion unit or 6.4% volume erosion in the European Union region, reflecting a decline in cigarette industry volume due to continued economic woes, particularly in Southern European markets.

In 2012, we achieved strong market share performances across all four regions, with gains of close to one share point in the Asia, EMEA and Latin America and Canada regions, and an essentially unchanged share in the European Union region, despite significant competitor trade loading in Germany at the end of the year.

As a result, our global market share excluding China and the USA increased by 0.5 percentage points to a record 28.8% in 2012.

Our global volume and share performance should be solid in 2013 and we anticipate organic volume growth of up to 1% excluding the Philippines.

Continued strong pricing across all four regions was the key driver of our revenue and OCI growth, generating a favorable variance of $1.8 billion in 2012.

We incurred a slightly unfavorable volume mix variance, with positive volume, stable brand mix, and an unfavorable geographic mix.

Indeed, absent the Japan hurdle, our volume mix variance would have been positive which we view as a significant achievement.

In addition, we increased our investments in the Business, notably in Germany, Indonesia, and Russia, focusing in particular on our key brands in market field forces and infrastructures.

In 2012, net revenues grew by 5.6% excluding currency and acquisitions.

On the same basis, adjusted operating companies income increased by over $1.1 billion or 8.1%.

These growth rates were at the high end of our mid- to long-term currency neutral annual growth targets of 4% to 6% and 6% to 8% respectively.

Our strong business results and our substantial share repurchase programs enabled us to increase our adjusted diluted earnings per share to a level of $5.22 in 2012, representing a growth rate of 11.7% excluding an unfavorable currency impact of $0.23 per share.

We enter 2013 with strong business fundamentals and excellent trends and we are optimistic on the prospects of our business.

With the recent exception of the Japanese yen, exchange rates have generally stabilized compared to 2012 and we are forecasting a currency headwind of approximately $0.06 per share in 2013 at prevailing rates.

We must recognize, however, the currency rates remain volatile.

Our reported diluted earnings per share guidance of prevailing exchange rates is in a range of $5.68 to $5.78 versus $5.17 in 2012.

This corresponds to a growth rate excluding currency of 10% to 12% compared to our adjusted diluted earnings per share of $5.22 in 2012.

Thus, we, again, expect to meet our mid- to long-term currency neutral annual EPS growth target in 2013.

This would be the sixth consecutive year of achieving this target.

This guidance factors in the expected impact of the disruptably large excise tax increase that took place at the beginning of this year in the Philippines.

A new law increased the excise tax on premium price Marlboro and low price Fortune from 12 to 25 pesos and from 2.72 to 12 Pesos per pack, respectively.

In response, we've increased the recommended retail price per pack of Marlboro from 32 to 51 Pesos and that of Fortune from 15 to 25.5 Pesos.

It will take several months before we can accurately gorge the actual impact of such pricing on total industry volume and on potential consumer down trading.

The volume impact, however, is expected to be considerable in a range of 20% to 25%.

We nevertheless anticipate that the impact on our earnings will be marginal given our pricing actions.

I would like to say a few words about one of the key regulatory challenges that we are facing, the European Unions proposed new tobacco products directives or TPD.

Let me emphasize at this stage, it is a proposal, the content of which still has to be approved by both the European Council of Ministers and the European Parliament.

During this review process, it may be amended and the final outcome remains uncertain.

Once a consensus is reached by both the Council and the Parliament, the TPD has to be transposed into local laws by each member state.

The European Commission has indicated that it expects that it will take through 2014 to reach an agreement and the full implementation will only incur in 2015 or even 2016.

The proposed TPD does not mandate plain packaging as was feared, but it does contain a number of proposals that we believe have no credible scientific basis and would be counter productive.

These relate both to products and their packaging.

It calls notably for a ban on menthol and slimmer cigarettes and the introduction of 75% graphic health warnings.

Menthol and slimmer cigarettes accounted for approximately 10% of European Union cigarette industry volume in 2012, though in markets such as Poland, they counted for about one-third of consumption.

We believe that such measures would inevitably lead to both an increase in illicit trade and a reduction in government revenues with no benefit to public health.

Rest assured that we will do everything in our power to ensure that reason prevails and that the obvious unintended consequences of the current draft do not materialize.

As mentioned earlier, we expect to achieve organic cigarette volume growth excluding the Philippines in 2013.

Strong volume growth in the EMEA region and the other Asian markets is forecast to more than offset continued volume declines in the European Union region, where no significant overall improvement is foreseen until the current high levels of unemployment are meaningfully reduced.

Our key premium brands, Marlboro and Parliament, are performing strongly.

Their volume and share are expanding across a wide range of geographies.

Our overall brand portfolio is in excellent shape with a strong complementary presence in profitable mid- and low-price segments.

The global excise tax environment remains reasonable with the obvious exception of the Philippines, and the pricing environment continues to be favorable.

Pricing will again be the key growth driver of our earnings.

Some 75% of our anticipated pricing variance in 2013, upon which our guidance is predicated, has already been implemented or announced.

The Asia, EMEA, and Latin America and Canada regions are forecast to generate strong OTI growth again this year, while we expect to be able to maintain our current high level of profitability in the European Union region excluding currency.

Our brands are performing very well with eight of our top 10 brands increasing volume in 2012, excluding the Japan hurdle.

Arguably, our greatest achievement in 2012 was the continued growth of Marlboro with its architecture firmly in place, complemented by the new campaign and the continued rollout of an array of consumer relevant line extensions across the Flavor, Gold, and Fresh lines, Marlboro continued to expand its share on a global basis to reach 9.3% excluding China and the US.

For the first time since the 2008 spin, Marlboro grew share in all four regions, underscoring its enhanced brand equity, continued relevance, and renewed vitality.

Above premium price Parliament achieved double-digit volume growth last year to reach a total of 43.4 billion units.

This excellent result was driven by its superb performance in Turkey, Russia, and across Eastern Europe, as well as in Middle East.

Parliament has a refined luxury image and has benefited from packaging upgrades and the launch of the industries first ever recessed filter capsule product in Korea.

We're also very pleased with the renewed strength of L&M in 2012.

Volume grew by 4% to 93.7 billion units.

This growth was driven by increased availability in Egypt, the long awaited turnaround in Russia, a strong performance across the Balkans, share gains in Thailand, and a higher volume in Turkey.

In the European Union region, L&M continued to grow share in its five most important markets, namely Slovakia, Poland, Belgium, Germany and the Netherlands.

However, this was offset by a share decline in markets in the southern part of Europe, largely compensated by share gains on Chesterfields.

On a regional basis, L&M's share was stable at 6.6% last year.

Our leading position and our strong share growth momentum in Indonesia gives us a unique position in the global tobacco industry.

Based on an expanded Nielsen coverage, we have updated our market data on Indonesia.

In 2012, we estimate that the total cigarette industry volume increased by 8.2% to 303 billion units driven by favorable demographics and a strong economy.

We expect continued strong industry volume growth in a range of 5% to 6% going forward.

Our volume surged by 17.5% last year and we expanded our market share from 32.8% to 35.6%, a gain of 2.8 share points.

Our strong premium SKU portfolio led by Sampoerna 'A' and our superior national distribution was reinforced by favorable retail price points.

I would also like to highlight our strong performance in two EMEA Markets.

Our volume in Russia increased by 3.8% last year while total industry volume declined an estimated 1.3% over the same period driven by higher prices.

In 2012, we gained 0.5 percentage share points thanks to the strength of our broadly based portfolio and investments in marketing and sales.

The key drivers of our market share growth were above premium Parliaments, mid-priced L&M, and low-priced Bond Street and Next.

Importantly, we improved our position in the growing slimmer diameter segment.

Last autumn, the Russian Parliament approved excise tax increases for 2013, in line with its previously published plans.

Subsequently, we registered new retail prices with increases of RUB6 to RUB7 per pack across our portfolio.

In Turkey, total cigarette industry volume grew by 8.8% last year to 99 billion units driven by a reduction in illicit trade, trade loading in the fourth quarter of 2012, ahead of a foreseen excise tax and price increase, a weak fourth quarter 2011, growth in the adult population, and a strong economic environment.

Our volume increased by 12.7% last year and we expanded our market share by a further 0.9 points to 45.7%.

At the same time, we improved our mix behind the growth of premium Parliament and mid-priced Muratti.

In January, we increased our retail prices by TRY1 per pack in response to the excise tax increase that was announced by the government.

The new excise tax regime now includes a specific element for the very first time.

In contrast, the business environment in the Southern part of Europe remains very challenging, as illustrated by Italy where unemployment reached 11.1% in November 2012, 1.7 points above the prior year level.

In 2012, Italy's cigarette industry volume declined by 7.9% as adult smokers, impacted by a reduction in purchasing power, switched to lower tax fine cut products and to illicit trade which grew by some 40% and 80%, respectively.

However, during the year, the government reduced the tax differential between fine cut and cigarettes.

Consequently, the growth of the fine cut category slowed to less than 2% in the fourth quarter when cigarette volume declined by a more moderate 4%.

Despite this challenging environment, our brands performed strongly in Italy.

Marlboro grew its cigarette market share by 0.6 points to 23.1%.

The growth accelerated in the fourth quarter when its share increased 1.3 points to 23.5%.

We successfully launched Philip Morris Selection in the growing international low-price segment at the beginning of 2012.

It achieved a 0.5% share for the full year and 0.8% in the fourth quarter.

Finally, Chesterfield, in addition to holding its own in the cigarette category, obtained a 23.5% share of the fine cut category.

While revenue growth remains the key to success in our business, we continue to be very focused on cost controls and productivity gains.

Our adjusted operating companies income margin increased in 2012 from 44.1% to 45.2% excluding currency.

This improvement reflects not only higher pricing but also limited cost increases, our success in surpassing our $300 million one-year productivity target and our continued efforts to optimize our manufacturing footprint.

This year, we are targeting a further $300 million in productivity savings to help offset expected moderate increases in leaf and direct materials, as well as higher clove costs.

While our business continues to generate growing amounts of cash from higher earnings, our free cash flow of $8.4 billion in 2012 was down $1.1 billion, or 11.6% excluding currency.

This decline was attributable to higher working capital requirements of $1.7 billion, as well as a $220 million increase in capital expenditures.

The working capital increase was primarily driven by Indonesia, where our business growth led to higher tobacco leaf and finished goods inventories and where we took advantage of a larger, but admittedly significantly more expensive clove crop, to build stocks for future business growth.

In addition, we needed to replenish our global tobacco leaf stocks following our unexpectedly large cigarette sales in Japan in 2011.

The increase in capital expenditures is attributable in particular to production capacity increases in the Asia and EMEA regions.

We anticipate a strong increase in our currency neutral free cash flow in 2013, though we do plan further increases in capital expenditures related notably to additional capacity in Indonesia and to the establishment of Next Generation products manufacturing capacity.

In addition, as has been the case historically, forestalling related inventory requirements can fluctuate significantly and are difficult to forecast accurately.

However in 2013, we project that our cash flow growth will exceed that of our earnings growth.

As you can see on this chart, since the 2008 spin, we have transformed a higher proportion of our growing net revenues into free cash flow than any of our consumer product in tobacco industry peers.

In September last year, we increased our dividend by a further 10.4% bringing the cumulative increase since 2008 to 84.8%.

We initiated a new three-year $18 billion share repurchase program in August 2012.

Last year in total, we spent $6.5 billion to repurchase 74.9 million shares.

We remain committed to a balanced program of returning cash to our shareholders through dividends and share repurchases, and we target share repurchases of $6 billion in 2013.

In conclusion, we expect to deliver strong results again in 2013.

Our diluted earnings per share guidance is $5.68 to $5.78.

This corresponds to a 10% to 12% growth rate excluding currency compared to our 2012 adjusted diluted earnings per share of $5.22.

This is fully in line with our mid- to long-term currency neutral annual EPS growth targets, which we have achieved or surpassed every year of our existence as an independent public Company.

The excise tax and regulatory environments are, we believe, manageable.

The pricing environment remains favorable and we have already achieved 75% of the pricing that is baked into our 2013 guidance.

We forecast organic volume growth this year excluding the Philippines.

We have strong growth momentum.

Marlboro gained share in all four regions, Parliament achieved double-digit volume growth, and our Business in the Asia and EMEA regions is in great shape.

The EU region remains fragile, but we certainly do not anticipate a deterioration versus the overall consumption trends we observed in 2012.

We forecast strong free cash flow growth excluding currency this year and we remain committed to generously rewarding our shareholders through attractive dividends and substantial share repurchase programs.

Since March 2008, we have returned a total of nearly $50 billion to our shareholders and repurchased 23.2% of the shares outstanding at the time of the spin.

Thank you for your attention.

Jacek and I will now be happy to answer your questions.

Thank you.

We will 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, Louis.

Hi, Jacek.

Good afternoon, David.

Louis, first a question on the guidance, and fundamentally it's whether, are you being conservative in your initial outlook because it's early in the year, or are there some things to be mindful of particularly this year?

And the reason I ask it is that in the year just concluded, you did 11.7% underlying local currency EPS growth and that was despite the Japanese hurdle which you aren't going up against this year.

That's correct, David.

No, I don't see anything out there that is of concern to us, but in the Philippines we have mentioned for some time and that's baked into our guidance.

I have to say that southern Europe, as I mentioned in my remarks, continues to be fragile.

As opposed to what others may have said, we've actually have not detected a deterioration in trends.

In fact, if you look at four quarter trends, they were better in every single market in the European Union with the exception of Spain and Italy whether you look at it from a total cigarette point of view or cigarette including OTP.

France has been slightly weaker because of the price increase, but we've detected a significant improvement in the trend from October, November, December and even January now, so the watch out is southern Europe.

Elsewhere, we're in great shape, I think, David.

Asia and EMA are growing strongly and growing in a quality manner.

If I look at EMA alone and you look the their growth, 60% of their growth came from pricing and 40% from volume mix which is quite a phenomenal achievement.

And if you go to Asia pricing was 70% but volume mix contributed 30%.

So I'd say we're in very good shape.

You may call our guidance conservative.

I think at this time of the year, we always have to express caution and we'll see how the year unfolds, but we certainly have momentum going forward.

Okay, and then, Louis, if I could one other quick question.

You have, obviously, a major competitor domiciled in Japan and with the weakness in the yen there's presumably some prospect that that competitor could elect to be a little more price aggressive than otherwise would be the case.

Is there any evidence of that materializing to any extent to this point?

No evidence whatsoever, David.

In fact, I was very encouraged that they increased their earning guidance to reflect the weakness of the yen, so that's a positive sign.

And I would say that in terms of pricing things are looking pretty good.

Okay, great.

Thank you.

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

Thanks, good afternoon, everyone.

Good afternoon, Judy.

Louis, just on your volume for 2013, so if I understood you correctly, you said Philippines down 20% to 25%, so that's probably a negative 2.0 to 2.5 points of an impact.

If we assume that the underlying volume trend ex-Philippines kind of stay what we saw in 2012, up 2% ex-Japan, is the kind of all-in volume outlook for 2013 close to flattish?

No.

As I said in my remarks, we see organic volume growth of about 1% this year, excluding the Philippines.

If you include the Philippines, and your calculation was right as to the impact of the Philippines, it was down about 1.5%.

We've had significant price increases in a number of markets.

Russia has been a significant price increase.

It's being implemented in the market as we speak so it's hard to gauge at this point what will happen in terms of volume.

We don't anticipate dramatic deterioration at all, but it remains a watch out.

Southern Europe, as I said, we believe that the trends are likely to remain the same as last year.

There could be upside, Judy, but it's a bit early to call that.

We'll see as the year unfolds and certainly when Jacek takes you through April and the first quarter we should have a much better read of Europe.

So that's where we stand, Judy.

Okay.

And then, Louis, if I just kind of take a step back and I look at your portfolio from a geographic exposure perspective, you've got now about 55% of the profit coming from sort of the non-OECDs,and excluding Japan and Europe, and those markets are growing profit double-digits, so when I think about your long-term growth algorithm, 6% to 8%, if you can maintain that 55% of your business growing at a double-digit, you probably only need flattish kind of growth in Europe and Japan from an operating profit perspective.

So I guess my question is, kind of, is there upside to that Europe Japan profit growth number going forward or is there downside to kind of that double-digit growth from a profitability perspective on these non-OECD markets?

No, I think your analysis is very accurate, Judy.

We've always said that we feel that European Union one day will come back, but we need to see some meaningful efforts to get the employment rates back up, and the economies remain fragile and there is still quite a lot of restructuring to do, but we are somewhat optimistic that governments seem to be now weary of the austerity push and are trying to focus a bit more on employment.

So, yes, if the EU were to improve that would, obviously, increase our growth capacity.

As to Japan, I would say one of the highlights, for me anyway, of Japan of 2012 was that the market was relatively stable relative to the secular decline trend that we had witnessed previously.

So we enter the year with a pretty strong market.

Our share, as you noticed, increased sequentially from the third to the fourth quarter, so we hit 27.7%, which admittedly was lower than our exit share in 2011.

But if I look at our January share in Japan it was 28.3%, so Japan volume, I think, is potentially stronger than it has been in the past, but clearly income will come from pricing, and in terms of pricing, we are a follower in Japan.

We tried to lead once and clearly, we need to follow.

Okay, that's helpful, thank you.

Thank you, Judy.

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

Good afternoon.

Hi, Bonnie.

Hi.

My first question is on net price realization.

You mentioned key growth driver this year is your price utilization.

It looks like you generated maybe around 4.5% net price utilization on an organic basis last year which is very positive, but I think down from historical net price realization of maybe mid- to high-single-digits.

So I guess I'd like to understand what gives you the confidence that you can reaccelerate price realization this year given the tough macroeconomic environment?

And then I think you mentioned you've already put 75% of your pricing actions in the market, so I'm just trying to understand the probability of these actions sticking and also love to hear from you, Louis, if this is typical that you've typically started a year with this much pricing action already in place?

I believe, if I look at the last three years, we've sort of hovered around 60% to 70%, this is 75%, so we feel we're in pretty good shape.

And, yes, pricing has been the driver and will continue to be the driver of our growth.

There's not much I can add to that, Bonnie, as you know, pricing is always a very delicate subject.

No, that's fair, but I guess that was helpful to understand that you've put more in place early on in this year than you typically have, so that's helpful.

I guess I also have a question on Asia and specifically Indonesia, very impressive growth as you've highlighted for us, and as I look back at some of my modeling work it looks like your profits in Indonesia could actually soon surpass the profits you generate in Japan so my first question is what's a realistic growth forecast for this market in Indonesia and could you maybe touch on potential opportunities you have in Thailand, Vietnam, and maybe other key markets in Asia that could be a nice surprise for us over the next few years?

Well, it clearly would be a lofty ambition for us to get Indonesia up to Japan in the very near future.

I think one day, yes, that is very possible.

It also relates to Judy's question earlier, the market in Indonesia has been growing at more than 8% back in 2011 and 2012.

This year we forecast a growth of 5.6%, 5% to 6%.

I think that also translates into higher pricing because clove costs have increased significantly and they have increased for every player in the industry.

We see our variable costs increasing by about 3.5% going forward and half of that, half the increase in total Company relates to clove costs, so that will require pricing in Indonesia which may somewhat temporarily slow down the growth we've seen in the past couple of years.

Having said that, we continue to feel optimistic that we will continue to gain share, essentially all of our brands gained share in 2012, so we have momentum.

So, yes, Indonesia is a jewel.

As to the rest of Asia, I think we're performing very strongly in various markets and, of course, China is still out there one day and the market still continues to grow.

Okay, thank you.

Thank you, Bonnie.

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

Hi, good afternoon.

Hi, Vivien.

How are you?

Very well, thank you very much.

My first question has to do with the EU, and I fully appreciate that you're not expecting a deterioration and things seemingly are so bad already, that seems fair enough from a macro perspective, but what gives you confidence that you won't see an acceleration in illicit trade as the consumer remains cash strapped?

Because if we look at the pricing environment in the EU we don't see a major acceleration.

There's been equalization on fine cut, so people -- tax equalization on fine cut a number of places, so people moving back to cigarettes as I showed in Italy in my remarks.

Illicit trade continues to be a concern.

Our sense is last year it was about 11.1% the consumption relative to 10.4% in the previous year, so its grown.

And our hope is that governments -- and we're doing a lot of work -- as you know, we signed an agreement with Interpol.

There's work on tracking and tracing to ensure that we can fight the illicit trade, as has been done successfully in other markets, most notably last year in Turkey.

Fair enough.

That makes good sense.

Switching gears to Next Generation products, when we were in Lausanne in June you mentioned that there were short-term clinical trials underway on your Phase I product.

Are you able to give us an update on how those went?

There's not much I can say, Vivien.

So far all the results we have are extremely positive and the green lights are shining, so we continue, but there's still a lot of work to be done on risk assessment, as well as, clearly, on the regulatory front.

In the meantime, as I alluded to in my remarks, we will be starting investments in setting up manufacturing capacity for those products.

So that tells you that we continue to very firmly believe in them.

Fair enough.

And my last question has to do with plain packaging.

I know Australia is a very small market for you, but could you give us your read on how plain packaging has affected that market?

Well, as you know, it was implemented effective December 1. There was a bit of turbulence in the market, retailers in particular found it very difficult to adapt.

Some of our competitors were slightly out of stock, so our share was actually quite strong in December.

But all the daily sales we see and the research we've done, there appears to be no change whatsoever in terms of our sales levels, incidents, or brand choice.

Having said that, it is still very early days, and we'll see what happens over a long-term period.

And I think other governments will watch the Australian example very carefully and my sense is that wisdom would dictate that people would look at the Australian example before they take on this policy measure which we believe will do nothing to help public health.

That's great.

Thank you very much.

You're welcome.

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

Good afternoon, Louis.

Good afternoon, Erik.

If we could follow-up on the plain packaging issue, in particular with respect to the status of the WTO and BIT challenges, and then I was curious with respect to the tobacco products directive, what implications in its current form does that have for Philip Morris' NGP business?

Thanks.

Well, in terms of the BIT claim, that is proceeding essentially according to schedule.

We still feel that the merits of our case is very strong, but it will be a two-year process, Erik.

There's not much more than I could say on that.

The arbitration panel has been formed, the procedural elements have been set up, and now there's a whole schedule of our claim being filed and then the response from the government and then hearings, et cetera.

But as I said, it will be a two-year process.

On the WTO aspect, that claim is proceeding.

The very interesting thing is that there are some 31 countries that have asked for observer status including such major countries as China.

I'm told that that is probably the highest ever level of countries that have asked for observer status which shows the interest there is on this issue in terms of plain packaging and the violation of the trademark rights.

With regard to the European TPD on NGPs, it's still early days, Erik.

As you know, there are either tobacco products or pharmaceutical products, so it doesn't in any way curtail the ability of the Company to do NGPs.

But, frankly, the thresholds that are within the proposal, I think, are subject to considerable debate and my sense is that before that proposal is put to bed, things are likely to change because essentially the thresholds were based on existing nicotine replacement therapies as opposed to new products.

Okay, thank you.

And then with respect to Russia, that appears to be quite a robust market in terms of up trading, favoring Parliament to Marlboro.

I was wondering how should we think about the evolution of the market through the remainder of 2013 with respect to lower price?

Are we seeing the market separate into premier-oriented and then discount or how is that developing from a Philip Morris point of view?

Thank you.

The low segment, Erik, continues to decline.

I think over the last couple of years it has declined by 10 share points, and that's moving up to what we call value mid and premium, more recently premium has been sort of flattish.

As you know there's been quite a significant price increase.

As I mentioned earlier, prices are actually coming into effect in the market as we speak.

The percentage gap between low value and premium actually is going to narrow and empirical evidence would suggest from various other markets that when the percentage gap comes down or narrows that generally actually helps up trading.

So we don't really anticipate any change in the trend and we certainly anticipate continued share growth with Parliament.

With regard to Marlboro, as you know, we've put in a number of new products to enhance the brand equity of the brand.

We said it would take quite a long time.

Share has been pretty well flat over the last four months which is already an improvement over the erosion the brand has suffered in the past.

The consumer research we have is clearly very positive virtually on all fronts, but before that translates into share growth, I think it will take some time.

In the meantime, we will continue to work that brand because we honestly believe that it does have considerable untapped potential in this very significant market.

Okay, thank you.

Thank you, Erik.

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

Good afternoon, gentlemen.

Hi, Jonathan.

Hi.

Just going back to the European Union, with the increase in unemployment and that the rates of decline that we've seen in volumes, do you think there's been a change in price elasticity and would that change again if illicit trade and [roll around] was brought under control?

I don't think there has seen a significant change in price elasticity, per se, Jonathan.

I think it's really, purchasing power has declined quite considerably, so people are looking for cheaper alternatives.

Governments have noticed that and they're trying to both equalize the tax burden on fine cut and cigarettes to protect their revenues, and also there is, clearly, a renewed effort to try to fight contraband and especially the advent of illicit whites and counterfeit.

It's actually quite ironic that the European Union tobacco product directive, when smuggled product represents some 11% of consumption in Europe, they want to ban slims and menthol that are about 10% of consumption.

That's the size of the French market or the Spanish market, in fact, slightly higher.

So there's a lot to be done on this TPD because clearly illicit trade, everybody has to get together to fight it.

Okay.

Just regarding the exports that go into Japan, can you just remind us what your hedging policy is on the transaction of that?

Well, we try to hedge it occasionally and this year we have hedged 50% of our yen exposure.

We did it several months ago, so, obviously, at attractive rates relative to the spot rate.

Nevertheless, we still have 50% exposure on the remaining balance, but I'm glad we at least have hedged 50%.

But that's just a transactional exposure, certainly not the translational, you mean?

Yes, we never hedge translation.

Great, and lastly, the trade load in the fourth quarter, I think you mentioned (inaudible) sort of 60 basis points so roughly speaking that sort of $45 million to $50 million in sales and profits?

Yes.

Yes, okay, thanks very much.

It varies by the market but it's principally in the EMA markets.

Okay, great.

Thank you very much.

Thank you.

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

Hi, good afternoon, Louis.

Chris, good afternoon.

Hi.

I just had two questions for you.

The first one, a bit of a follow-on there to Jonathan's question regarding the inventory overall helped your volume in the quarter, but I think overall would it have been a drag on your EU volume in the quarter and could you quantify that effect in rough terms?

In EU, it was essentially neutral.

The one thing that affected us was more in terms of share because there was a lot of loading in Germany by some of our competitors, it was significant, and to give you a sense of the significance our January share in -- our January share in Germany was slightly above 41%.

Okay, and then I had a follow-up question for you also about the EU, and just kind of a bigger picture question, if you will.

In the current environment that we're in where you have volumes going down at a more aggressive rate, you've had some pretty good price realizations still to help offset that.

I guess I'm just curious, maybe it's from a fixed cost standpoint, or what you need to do to help keep profitability flat or even growing in that market?

Do you need to do some sort of restructuring or asset work to try and keep that profit growth in that flat to up region if we're in the environment that we're in today?

Well, first, Chris, we don't see a deterioration in the volume trends and your question was premised on a sort of more aggressive down trend which we really don't see.

And as I mentioned to Judy earlier, there may be upside but it's a bit early to call.

With regard to our cost structure, we've always been very careful to ensure that we're as cost efficient as possible.

Our European factories supply a number of markets so they're running at pretty good capacities.

We have invested a considerable amount of money in marketing and sales forces in Europe to gain share and we continue to gain share.

And if you recall, and we highlighted this in our earnings release, Marlboro was up in the European Union and its share actually accelerated in the fourth quarter, but it was up for the first time since 2002, so we're very encouraged by that.

Okay, thank you very much.

Thank you, Chris.

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

Thank you.

Good afternoon.

Good afternoon, Chris.

So just back to Japan, can you talk a little bit about, I guess, the cadence of new product flow, because to your point, market share increased sequentially while it's still down year-over-year.

I guess have we hit a flattening out point on share do you think and how much does it relate to your new product flow relative to the competition in the market?

Well, definitely product innovation is key to gaining share in Japan.

We think we have a pretty good program in place for 2013.

Our launches in 2012 were pretty successful, so we actually believe we can continue to gain share in Japan.

We said that the [exit] share was the base on which to go forward.

That was probably an ambitious target because JT probably hadn't gone back to its normal share, but, certainly, the January trend looks very favorable and given the product innovation we have going forward, we see opportunity.

As you know very well, JT is embarking on a very ambitious program to move Mild Seven to [med] use and we'll see whether there may be opportunities in there.

Great, and I guess just as a follow-up on the market, it's been awhile, I think, to your point, since you've seen a normalized volume number.

I guess, how would you characterize the sustainable market volume rate of decline in Japan at this point?

Well, last year if you, our best estimate taking care of inventories, et cetera, was that there was an underlying decline of about 1%.

And without any pricing we wouldn't see why there would be any difference in that coming forward into 2013, which is clearly a considerable improvement over the past.

Right.

Thank you very much.

You're welcome.

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

Thank you, good afternoon.

Good afternoon, Michael.

Just a question on your repurchase guidance.

I realize it's early and that it could certainly fluctuate, but with currency being such a headwind last year, it's a little surprising that your guidance would be less than you did already.

Was there some other, was there a factor in 2012 that would have helped make that bigger or what should we expect for this year?

Is it just a conservative starting number or how do you think about how those two compare?

Well, I don't think I'd call $6 billion conservative, but essentially, we have a three-year program that's $18 billion.

That makes it $6 billion a year.

If we went for $6.5 billion last year, it was at one point we felt that our stock price was clearly very undervalued, I think, possibly because of some sort of regulatory concerns or profit taking.

So we took the opportunity to buy more shares at what we thought was a very attractive price.

It's, I think, a very generous target and we hope that we'll be able to do the $6 billion this year.

Okay, that's fair.

And then, just looking at your business in Korea, it looks like your 4Q share was a little less than your full-year share, but I know there's an uneven pacing there.

Can you talk a little bit about the trajectory there and what the competitive dynamics look like?

Well, it's slightly distorted because we took a price increase back in February, if you'll recall.

So clearly January and February we had a high share and we suffered after the price increase.

However, our share has essentially been flat at about, for the last, I would say, seven months, so in terms of share, we're in relatively good shape in Korea.

What needs to happen in Korea is a reform of excise taxes and there are various proposals in the d legislature.

As you know, there's a new government in place, and, hopefully, with taxes that hopefully will be adjusted for inflation every year, that will give more flexibility in terms of pricing and clearly we hope that KT&G will move prices one day.

And then I realize, obviously, the politics are a little unpredictable.

In the meantime, do you have anything else that could bridge the gap like an innovation pipeline or something else that could help share besides more narrow price gaps?

Yes, most definitely.

We have a program in place to launch some pretty exciting new products as we did last year, so our ambition is to gain share.

Our profitability in Korea increased significantly last year because of our price increase, and I think our brand equity remains very strong, in particular, with Parliament.

And as I mentioned in my remarks, the Parliament capsule product, we think, has a lot of promise.

Okay, that's helpful.

And then in Indonesia, your share gains last year, obviously, were pretty significant, but you have several years where that's been the case, and I'd love to get a sense for what a sustainable trajectory looks like.

Is the source of share primarily the 20% to 25% of the category that's small fragmented players, so that you've got sort of a deep pool from what you can continue to draw?

Or what are some of the dynamics there, what's the source of your share and what can it look like in the next few years?

Well, that's certainly one of the sources, especially as the government continues to narrow the various tax tiers and the tax matrix, but I would say that our major competitive advantage is the investments we've made in our distribution infrastructure and field forces and in terms of our brand equities.

So we feel very good about our share performance in the past and our future prospects for share growth.

I would also say that because of the strength of the economy, there's clearly an uptrading trend and our share in the upper price segments is significantly higher than our total share of the market, so we have an ingrown share growth built in as those trends continue, and we see no reason why they should not continue.

As you're probably aware, they dramatically increased minimum wage rates in Indonesia recently, so clearly, that will benefit the uptrading trend.

That's helpful.

And then, just one last question on the Next Generation products.

I know an endorsement or approval or whatever the proper term is from the FDA would be sort of a passport to just about any market, but given the unpredictability of this administration in particular or just that they don't seem to be in any rush to support tobacco companies, so what are the options without that?

How big of a hurdle is it to have that and are you able to get similar approvals in markets that you would want to launch in that wouldn't necessarily need anything from the FDA to let you get a green light there?

Well, clearly, the FDA would be very helpful and we have engaged with the FDA, but it is not a pre-condition to launch in these products elsewhere.

We are in discussions with regulators and various jurisdictions, so that is an ongoing effort that's parallel to the one that's going on with the FDA.

FDA support would clearly be very helpful, but as I said it's not a pre-condition.

Thank you very much.

You're welcome.

Your next question comes from the line of Thilo Wrede with Jefferies.

Good afternoon.

Hi, Thilo.

Two quick questions for you.

First one in the Philippines, what's your level of confidence with this level of 20% to 25% volume impact.

If I remember correctly, the volume impact in Japan was supposed to be similar and it turned out to be much less dramatic, so how confident are you that this will happen in the Philippines?

Well, I would hope that it would follow the Japanese example.

The Philippines is doing well economically.

Worker remittance has continued to increase, so the macros look quite favorable.

Nevertheless, it's a significant price increase.

My concern, Thilo, is really the advent of contraband and, as you know, there's a lot of contraband product in other categories in the Philippines, and also potentially tax avoidance by some of the other players which is we've seen in the past.

So hopefully the government can clamp down on that.

They've said that they would have, institute very strict product tracking and tracing systems at the manufacturing end.

Listen, today as I said in my remarks, it's a hard one to call.

It could do better, and if so, I'd be the first to be delighted.

Fair enough.

And then, Louis, when you look out for the year, and you look at the macro headwinds in southern Europe, you look at the noise from planned packaging, you look at tax increases in the Philippines, you look at illicit trade in Europe and so on, is this the most challenging environment that you operate in, be it from a true operational perspective or just from a noise perspective since the spin-off from Altria?

I'm not sure that it's the worst.

We've lived with it for a little while.

I would say that the strength of this Company is irrespective of what's thrown at us.

We have various points of leverage to meet our ambitions and that's what makes this Company great.

So you're not concerned about all that noise that's out there?

Of course, I'm concerned about it, but I think we can overcome it.

And as you say, a lot of it is noise as opposed to real action.

Okay, great.

Thank you.

Thank you.

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

Hi, Rogerio.

Hi, everyone.

I have one question about consumer uptrading in emerging markets.

Among your top non-OECD markets which ones are standing out in terms of positive variance in the premium share of the market?

I recall Mexico and Indonesia stood out in the first half, so I was just wondering if they remained a bright spot in Q4, or were there any other markets that are now standing out?

Thank you.

If I look across the world, essentially, they're all going up in terms of emerging markets.

Clearly, the ones you mentioned are Turkey, Indonesia, Mexico, Brazil, pretty well everywhere at the moment.

Philippines were somewhat distorted because there was trade loading by the competitors, but we see, if I look at Vietnam, Malaysia, you name it, there's pretty well uptrading across the board.

Great, thank you, Louis.

And just one question about France, have you not seen any sequential deterioration in volume trends?

It looks like the total market was down 7% in Q4, any color would be appreciated.

Thank you.

Actually, no, in France you're right, Q4 was down, but it improved as the quarter essentially unfolded.

And, in fact, if I look at January, total volumes were down 3.4%, so that's clearly an improvement over the fourth quarter which was distorted by the October price increase.

It's very helpful.

Thank you very much, Louis.

You're welcome.

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

Hi, David.

Good evening, gentlemen.

Hi.

Two for me if I can.

Just in terms of the brand support and the infrastructure investment that you talk about in terms of the [Be] Marlboro success in Europe and then in Russia, as well.

How should we think about that in terms of that continuing into 2013?

Was there a ramp up in '12 and that comes off a little bit, or do we see another step change again in 2013?

And the second question for me was getting back to Japan, obviously, no tax raise.

JT seemed to allude to the fact they were trying to get a price rise maybe still.

Just wonder whether you would make any comment about whether you think the environment, the regulatory environment there would allow for that and whether your guidance would assume any price rise in Japan and whether that would be upside to what you've outlined today?

Thanks very much.

You're welcome, David.

First question, yes, there will continue to be a ramp up.

There was in '12 and there's actually going to be, we forecast a considerable ramp up in 2013 of the Be Marlboro campaign and all of the consumer trade engagement programs that we have as they are slowly rolled out across the world.

In terms of JT, the partial privatization, I think, nobody is quite aware of the timing and we'll see when that happens.

It may trigger JT's desire to increase prices or enhance their ability to do so.

If JT were to increase prices that would be terrific news and, yes, it would be an upside.

Okay, that's great.

Thank you very much.

You're welcome.

Our final question comes from the line of Ann Gurkin with Davenport.

Hello, everyone.

Hi, Ann.

The best for last.

Hi.

I had a question regarding Russia and if Russia decides to ban smoking in public places, how do you incorporate that into your outlook particularly in the second half for calendar '13?

We don't anticipate a major impact, and it's not at all sure there would be -- there is a reading, I think, for February 12 of the Tobacco Control law and we'll see what happens there, but we don't anticipate any major shift in trend, Ann.

Okay, great.

And then, I always like to ask about leaf costs, and listening to your comments about expecting moderate increase in leaf prices in '13, is that trend in pricing in line with your expectations following your vertical integration move, is that following within that kind of band of pricing expectations or do you think you need to make changes to vertical integration?

No, it's fully in line with our expectations and there's not much I can add to that.

I think the one that I highlighted will be a cost driver is the clove costs, that's the main driver.

Leaf is certainly increasing at manageable levels.

Perfect.

In line with our expectations.

That is great.

Thank you so much.

Thank you very much, Ann.

Thank you.

That was our final question, and now I'd like to turn the floor back over to Nick for any closing comments.

Well, thank you very much for joining us.

That does conclude our call for today.

If you have any follow-up questions, please contact the IR team, we're currently in New York today and tomorrow.

And just as a reminder, our next presentation will be at the Consumer Analyst Group of New York, or CAGNY Conference, in Boca Raton, Florida on Wednesday, February 20, and that presentation will also be webcast.

So thank you again, and have a great day.

Thank you.

This concludes today's conference call.

You may now disconnect.