菲利普莫里斯國際 (PM) 2014 Q2 法說會逐字稿

Good day, and welcome to the Philip Morris International second-quarter 2014 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)

I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications.

Please go ahead, sir.

Welcome and thank you for joining us.

Earlier today we issued a press release containing detailed information on our 2014 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 2014 and comparing them to the same period in 2013 unless otherwise stated.

A glossary of terms; data tables showing adjustments to net revenues and OCI for currency, 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 are at the end of today's webcast slides which are posted on our website.

Please note that reduced-risk products, or RRPs, is the term we use for products that have the potential to reduce individual risk and population harm.

Today's remarks contain forward-looking statements and projections of future results.

I direct your attention to the forward-looking and cautionary statements disclosure, 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 is now my pleasure to introduce Jacek Olczak, our Chief Financial Officer.

Thank you, Nick.

Welcome, ladies and gentlemen.

As we expected, we achieved strong results in the second quarter, driven by a lower cigarette volume decline of 2.7% and a solid pricing variance of $494 million.

As a result, net revenues, excluding currency, increased by 4.5% and adjusted OCI was up by 9.5% on the same basis.

Both the EEMA and Latin America & Canada regions had a very strong quarter, with adjusted OCI growing by 28.8% and 27.1%, respectively, excluding currency.

Furthermore, the EU region achieved a 3.3% increase in adjusted OCI excluding currency, despite adverse pricing impact in Italy.

The results in the Asia region, meanwhile, continue to be impacted by challenges in specific markets, although we are making progress in dealing with them.

Our adjusted diluted EPS, excluding currency, grew by 20% to $1.56 per share.

This was driven by our strong business results and a relatively easy comparison with the same quarter last year.

For the first half of the year, our adjusted diluted EPS, excluding currency, increased by 12.4% to $2.91.

However, we will face much more challenging comparisons during the second half of the year and in particular during the fourth quarter.

In the second half, we will make investments behind the commercialization of reduced-risk products, rollout Marlboro Red 2.0, and incur some underlying costs related to the optimization of our manufacturing footprint.

Overall, our spending this year is geared towards the second half.

As a result, we are anticipating a lower EPS growth, excluding currency, for the second half of this year.

As we announced at our investor day in June and reaffirmed today, our reported diluted EPS guidance for 2014 at prevailing exchange rates is in a range of $4.87 to $4.97 versus $5.26 in 2013.

Our guidance continues to include approximately $0.61 per share of unfavorable currency at prevailing exchange rates, an after-tax charge of $0.24 per share recorded as asset impairment and exit costs in the second quarter related to the discontinuation of cigarette production in the Netherlands in 2014, and the $0.01 per share charge recorded in the first quarter relating to the decision to end production in Australia.

Our 2014 guidance represents a growth rate, excluding currency and these restructuring charges, of approximately 6% to 8% compared to our adjusted diluted EPS of $5.40 in 2013.

As stated in June, given the downtrading and heavy price discounting in Australia, in combination with plain packaging, we anticipated that this could result in our currency-neutral adjusted diluted EPS being at the lower end of this range.

Let me now provide you with an update on key markets, starting with the challenges we faced this year in a number of Asian markets and the progress we are making in addressing them.

In Japan, cigarette industry volume declined by 14.4% in the quarter as the trade destocked following their April 1 tax-driven price increases.

Our shipment volume decreased by 16.4%, reflecting the overall market decline and our lower market share.

On a June year-to-date basis, industry volume declined by 2.8%.

As expected, our market share in Japan rebounded during the second quarter, reaching 26.4% following our 25.5% share in the first quarter when the trade built up higher inventory levels of competitive product.

Adjusting for trade inventory movements, we estimate our share in the quarter was 25.8%, indicating that the process of stabilizing our market share is underway and we believe that our share should level out during the second half, a period during which we plan a number of new product launches including Marlboro Clear Hybrid, a smooth-tasting, regular to menthol capsule product.

In Indonesia, where weakness rebound in cigarette industry volume with a second-quarter increase of 4.9%, which brought the first half of the year to a 2% growth rate.

We are currently maintaining our forecast for the full year of market growth of up to 1%.

Our market share increased sequentially from 34.6% in the first quarter to 34.9% in the second quarter, though it was below the last year's level of 36.1%.

While the unfavorable trends in the handrolled kretek segment continue to impact our overall share performance, the decline moderated and we achieved strong share progression in the machine-made kretek segment.

This was helped by the April launch of Dji Sam Soe Magnum Blue, which reached a quarterly share of 0.6%.

We expect this sequential improvement to continue during the second half of this year.

Total estimated tax-paid cigarette industry volume in the Philippines declined by 13.4% during the second quarter while consumption levels remained resilient, as measured by adult smoking incidence and daily consumption.

The drop in tax-paid industry volume reflects the fact that Mighty Corporation's tax-paid volume was down by around 40%.

In contrast, we estimate that its total sales volume, both tax-paid and non-tax-paid, increased by about 20%.

PMI's share of the tax-paid market increased to 85.9% during the second quarter, representing an increase of 3.4 share points, driven mainly by Marlboro and Fortune.

The pressure on Mighty Corporation continues and we hope that the introduction of tax stickers, now expected in August, will reduce its ability to avoid paying excise taxes and VAT.

Let me now move to Australia, where the combination of a certain commoditization of the market induced by plain packaging, large excise tax increases, and heavy price discount in particular at the bottom of the market has accelerated down-trading to lower price, lower margin brands, or even illicit product.

The superlow price segment has grown from 6.3% in 2011 to 28.3% in the first half of this year, when the effective price gap between a premium brand, such as Marlboro, and a superlow price brand, such as Bond Street, widened to about AUD8 per pack of 25 cigarettes, or about 36%.

This compares to a gap of about 26% in 2011.

Our market share averaged 37.7% in the period 2011 through 2013, but came under significant pressure from competitive discounting in the first quarter of 2014 when it dropped to 32.9%.

We responded with increased investment and in tactical price discounts for choice and Bond Street in order to regain our market position.

As a result, in the second quarter we increased our segment shares in the low-end and superlow price segment from 31.4% and 11.2% last year to 36.8% and 14.5%, respectively.

However, the combination of increased price discounts and volume mix deterioration due to the down trading is impacting our profitability in Australia this year.

Let me now turn to the EEMA region, starting with Russia, where our strong and diverse brand portfolio is driving market share gains and enabling us to increase prices.

On a May quarter-to-date basis our market share increased by 0.9 share points to 26.8% thanks to premium Parliament, midpriced L&M, and low-priced Bond Street.

We estimate that cigarette industry volume declined by around 10% during the second quarter.

This was driven by price increases averaging some 25% year on year and increasing the prevalence of illicit trade and the weakening economy.

As you know, we announced in May a further price increase of RUB4 per pack across most of our portfolio.

This should impact adult smokers later this month and, along with the implementation of the restrictions on public smoking that were introduced in June this year, is expected to result in a full-year decline of between 9% and 11% in cigarette industry volume.

In Turkey, cigarette industry volume increased by an estimated 2.5% in the second quarter and was slightly up June year-to-date.

A stable underlying trend is expected during the second half of the year despite a midyear upward adjustment in the specific and minimum excise tax of 5.1%.

We increased the prices of our low and superlow price portfolio -- Bond Street, Chesterfield, Lark, and L&M -- by TRY0.50 per pack.

Our May quarter-to-date market share was marginally lower at 44.6%.

However, the premium brands' share of our portfolio increased, driven by the 1.2 share points gained by Parliament, which reached a record market share of 10.8%.

Let me now turn to the EU region, where June cigarette industry volume was stronger-than-expected and included a favorable inventory volume.

Cigarette industry volume declined by just 1.2% in the second quarter and by 3.4% in the first half compared to a 9.3% decrease during the same period last year.

The improvement in cigarette industry volume trends has taken place despite persistently high unemployment levels.

We attribute the moderation to a slight decline in illicit trade, a slowdown in the growth of e-vapor product in many markets, relatively less outswitching to fine cut products, and some trade inventory movement.

We should also remember that the comparison with 2013 was easier in the first half of this year, and in addition, we have recently implemented or announced price increases in Germany, Portugal, and Spain.

Consequently, we are expecting the full-year decline in the EU region to be approximately 5%, which is a more modest rate of decline than one forecast in June and a marked improvement on the 7.4% decline that occurred during 2013.

We continue to outperform the industry in the EU region.

Our regional market share increased by 0.9 share points in the second quarter to 40.4%.

We achieved share growth in five of the six largest markets in the region and expect our positive momentum to continue throughout the year.

Absent trade inventory movement, our market share would also have been up in Germany.

Our strong share performance is based on the strength of our key international brands.

Marlboro remained resilient with a 19.4% regional share, despite the continued weak macroeconomic environment.

L&M grew by 0.3% share points to 7.2%, driven by an outstanding performance in Germany and continued share gains in Poland.

Chesterfield performed particularly well, gaining 1.4 share points in the quarter to reach a regional share of 5.8%.

Its market share has grown very rapidly since we repositioned the brand in Italy and it has also benefited from geographic expansion.

On a June year-to-date basis, our cigarette volume in the EU region was essentially stable at 91.6 billion units.

This was the key driver of the improvement in our adjusted OCI, excluding currency, during the first half of the year.

Our pricing variance, on the other hand, was lower than in recent years, mainly driven by Italy, where we remain cautiously optimistic that the government will implement excise tax reform.

In the second quarter we increased our market share in Italy by 2 share points to reach 55.3% as Chesterfield, which was repositioned in February to the superlow price segment, achieved a 10% overall market share, up by 6.5 share points although with lower unit margins, while macro share declined 0.8 share points to 25%.

On a global basis, pricing remained a key driver of our higher adjusted OCI during the second quarter.

Our pricing variance reached $494 million in the quarter and $900 million in the first half, broadly in line with our annual historical average of $1.8 billion.

Our strong second-quarter pricing variance was led by Indonesia and Russia, but was partially offset by unfavorable pricing variances in Italy and the Philippines.

We achieved a 2.1 point improvement in PMI's adjusted operating company's income margin, excluding currency, in the second quarter, driven by pricing and helped by the timing of costs.

Looking at our top 30 OCI markets worldwide, our share in the second quarter of 2014 increased by 0.2 points to 37.3%.

Marlboro is one of the key drivers of our favorable market share momentum.

During the second quarter, Marlboro progressed to reach an international market share of 9.2%, excluding China.

It gained share in three out of our four regions with a particularly strong performance in the EEMA region.

The decline in the Asia region was mainly attributable to Japan.

We remain committed to generously rewarding our shareholders through a combination of dividends and share repurchases.

Our dividend yield last Friday was 4.4%, which put us at the upper end of the range of our peer groups.

During the second quarter we spent $1 billion to repurchase 11.6 million shares at an average price of $86.13 and continue to target spending of $4 billion during the full year of 2014.

In conclusion, the second quarter was financially a strong one helped by a favorable comparison with last year and hindered by some ongoing challenges in the Asia region.

The results in the EEMA and Latin America & Canada regions were particularly strong, driven mainly by pricing, while better volume trends in the EU region enabled us to increase regional adjusted OCI, excluding currency.

Our business fundamentals are solid, although the comparisons are expected to be more challenging during the next two quarters.

We will make investments behind the commercialization of reduced risk products, rollout Marlboro Red 2.0, incur some underlying costs related to the optimizations of our manufacturing footprint, and overall our spending this year is skewed towards the second half.

This is already reflected in our EPS guidance and we remain confident in our ability to achieve a growth rate in adjusted diluted EPS of 6% to 8%, excluding currency, for the full year of 2014.

Thank you.

I will now be happy to answer your questions.

(Operator Instructions) David Adelman, Morgan Stanley.

A couple of things.

First of all, I realize you haven't changed your outlook for the year, but did the second quarter come in higher than the internal plan?

Or was this what you, more or less, had envisioned?

No, this came as per our plan.

We knew and we have highlighted at the beginning of the year that we expect particularly strong quarter, partly driven by the comps.

As you remember, the growth rate in the second quarter of last year was 0.7% on EPS level, ex currencies, so it was not really a challenging comp which we were facing.

But also, we knew that we will expect some continued step-by-step improvements in the key markets where -- which we tried to address this year.

So you had the EU, Japan, Philippines, etc., so this all was baked in so it came as expected.

Okay.

Secondly, two of your three major international competitors intend to make fairly sizable investments in the US cigarette market, the conventional cigarette market.

And I'm just curious; you obviously exited that market but do their actions cause you to rethink at all the attraction and/or the risk of the US?

Well, not really.

I think we make it very clear that the reasons are well known why we focus on an international market.

We're not looking in a conventional business at the US.

I think our plans are very clear that, yes, we do see US from the perspective of the reduced-risk product, but that's a separate part of the strategy.

So when it comes to the conventional cigarette, cigarette market, I don't really see any impact in terms of our thinking of that transaction, which was I believe announced yesterday.

Okay, thank you very much, Jacek.

Judy Hong, Goldman Sachs.

A couple of questions.

First, in the EU region obviously you had called out the pricing variance being negatively impacted by the price repositioning in Italy.

So just wondering, number one, can you just quantify the Italy impact and whether the underlying -- the other markets the pricing variance has also slowed.

And then you've taken some pricing in some of the European markets, so would you expect pricing variance in the back half for EU to be much stronger?

On Italy, I think that the Chesterfield repositioning obviously generates some negative pricing variance on the Italian market, but this is largely offset by the volume gains.

So I think Italy is more a question of the VAT absorption, which we still have since the end of the last year, and this is causing the negative pricing variance.

This is very much linked to the way to discuss or debate in Italy, the tax restructuring.

Italy, to quantify; the total pricing variance for Italy would be in a range -- on the year-to-date basis you are talking in the range of about $100 million.

But as I said, it's more -- the higher component is the VAT absorption than just the repositioning of the Chesterfield, because you pick it up at the revenue level for the volume, positive volume variance.

Right, okay.

Then other markets where you are taking -- have taken more pricing, so broadly speaking, if you take total EU in the back half pricing variance would accelerate more meaningfully (multiple speakers) in essence?

Just to conclude, in Italy we would add to the pricing variance on the EU, the negative coming from Italy.

The EU would have already a pretty decent pricing variance for the first half of the year because Italy really depressed the pricing variance for the entire region.

And I think overall for the PMI, the pricing variance is about equally spread between halves of the years -- of the year.

Got it, okay.

Then the second question is relating to the situation in Australia.

Wanted to just get a little bit better understanding of what actions you've actually taken already in that market and whether there are more actions to come in the back half and just if you are detecting any sort of competitive responses now that you have responded to that competitive behavior in that market.

Well, what we did in Australia is, as of the end of the first quarter, essentially we've increased summer promotional spending, price promotional spending behind mainly two brands, Choice and Bond Street, which are the brands which are competing in the low-price segment, in the upper part of the low price segment.

And they are being challenged by the discount segment, so the lower part of that segment.

The investment and our actions around this when we tried to regain the competitiveness when it comes to the price point versus the key competitive brands, this is a free pricing in Australia so the situation is pretty dynamic.

And you appreciate that I cannot comment on future price moves, but this is a price discounting situation where the price is being set individually by the key accounts, by trade channel, by territory, etc.

So that situation may change and may turn -- may change pretty rapidly.

So we will have to see.

I think our share reacted as expected.

Again, the share, especially behind these brands in the second quarter.

As you remember, we lost some share significantly, some share in the first quarter so so far that part of the strategy works.

Now we will see how that situation will prevail.

I think what is maybe important to say that you have some brands already in the market discounted in the low price segment that are to the level that they essentially yield about zero margin.

So I think -- once you reach that point I think a fair question to ask is isn't that the moment when the logic should start prevailing while you start balancing your profit versus volume objective.

Right, okay, got it.

Thank you.

Chris Growe, Stifel.

I just had two questions for you, if you could.

The first would be, if you look at the EU, the first half benefiting from some inventory movements.

How much of that reverses in the second half of the year?

I guess, with the volumes being much stronger so far, do you have to -- see sort of major inventory reductions occurring in the second half of the year?

Small component.

I think it was mainly in Germany, but you're not talking about that very important component.

So, yes, there will be obviously some reversal in Q3, but I don't think it would change our outlook when it comes for the full year.

And as you notice, we have revised shortly after investors day when our -- having a full June data, we have revised our total industry outlook for the year to the 5%.

So, again, obviously some inventory movements between the quarters.

Okay.

Then just another question for you, if I could, on Japan, which is that obviously the share of shipments was up in the quarter, but that also was distorted by inventory movements.

So I'm just curious, what is a -- is there a better metric, a better measure for the ongoing share, if you will, in Japan this quarter?

(multiple speakers), is that sustainable or --?

The way we are tracking the performance we look at the retail offtake at some key to change there, but the share performance there is somehow reflecting the trend with sequential trends which we see on our adjusted churn.

So we start -- we see the stabilization of the share over the last three quarters, maybe 0.1 down sequentially Q2 versus Q1, but it is all pointing to what we expected.

In the second half of the year we should essentially have a Japan share pressure behind us.

Thanks for your time.

Bonnie Herzog, Wells Fargo.

Good morning.

My first question is on the Philippines, so despite progress being made with the tax underpayment issue by your main competitor, the market was still down quite a bit in the second quarter.

So how do you see this playing out for the rest of the year and when should we expect the market to stabilize?

Then also, do you think the tax stamps coming in -- I think it sounds like in August now -- will fix or address the bulk of these problems?

The market -- we have to be cautious when we talk about the total market size in Philippines because we essentially have a better visibility on a tax-paid market rather on a total market.

Therefore, I think also on our slides we are using the data on the consumption, the smoking incidence and the daily consumption, which gives a better feel what's happening to the total market covering both tax-paid and nontax-paid.

I think there was the distortion coming a little bit from what has happened Q2 last year with Mighty supplying the market and the Mighty level of supply in the market the second quarter of this year, hence, you have a 14% decline.

When it comes to second question, I think the tax stickers implementation is an important step in the whole portfolio of the steps which we wish the government should have already taken to address that issue.

I don't think tax stamps is the only element which is going to address that issue.

You know, when we are dealing with an under-declaration you need to, obviously, demonstrate the same diligence and the vigilance when it comes to all the things, the tax stickers, etc.

But we are very pleased that this is coming to fruition, to its realization, and I think it's going to help in overall addressing the situation.

Okay, that's helpful.

Then I do have a second question on Russia.

Could you give us a little more color on how Marlboro is performing in that country?

And then in light of the price increases you took, could you talk about where price gaps are now?

And are you seeing any changes in the consumer behaviors given the increases and then possibly from some of the smoking bans?

Well, when it comes to the price gaps, because Russia essentially is having a price increases the same absolute amount per pack across the price segment so it's not much change of the price gaps in absolute terms, but obviously the price gaps in the relative term tend to close.

When it comes to consumer reaction, the price increase which we announced in May, as I said in my remarks, will hit the markets around this time, early August.

So we will have to wait a month or so to have the reading how consumers -- what is the reaction of consumers.

I think we shouldn't change our outlook for the market, total market size for this year.

I think this 9% to 11% range of decline for this year is valid.

We factored in the impact of the two price increases this year and also in the forecast is factored in the impact from a smoking restriction in public places.

Okay, thank you, Jacek.

Eric Bloomquist, Berenberg.

Morning, a couple questions.

Firstly, following on in Russia.

I was just wondering if you could confirm that you are still seeing substantial uptrading.

It looks like Bond Street was actually taking a bit more share, say, relative to Parliament.

And then related to that I was wondering two things.

If you're -- what you are estimating is the effect from the greater smoking restrictions or is that going to be relatively modest?

And how are you characterizing the risk of a greater tax increase than in the current rolling two-year plan, say, in next year or in 2016?

Uptrading in Russia, because you're talking about the market which has a relatively high absolute and relative price gaps so uptrading is better.

You see uptrading better when it comes to the two segments next to each other and I think you will still see uptrading in the markets.

It's not a straight uptrading for the lower-priced product going into the premium product, but in the segments next to each other I think you will see some uptick in the volume.

Hence, the performance of the Parliament and also performance in the -- of our brands.

Usually our brands will tend to occupy the upper part of each respective segment.

The smoking ban, I would say like this.

We have experience in other markets from implementation of a similar regulation, similar restrictions.

Yes, you will have some impact at the beginning.

Usually it comes to moderation later on when the consumer adjusts to the new consumption pattern or accommodate the fact that there may be places or occasions when they cannot really smoke.

As I said, this is all factored in our 9% to 11% forecast for the total volume decline.

The key driver behind this 9% to 11% is the price increases on the back of excise increases, which we are taking this year.

So most of this 9% to 11% is the elasticity-driven impact on the total market rather than accounting from a smoking restriction.

And a third part of your question, we have now the second year where Russia is dealing -- the Russian government is approaching the taxation of the cigarette market through this three-year plan.

Every year the rates are getting reconfirmed around November, I think, in their legislative process, the Duma and the cabinet.

Every year they reconfirm the next two years and they bring -- and the rates for that third year in that plan is a rolling over plan.

So we will see how they reconfirm the rates this year.

So far, the government was very pragmatic in setting this rate.

On the one hand, balancing their desire to increase the tax level, but on the other hand recognizing the unintended consequences, namely the illicit trade, which they would not like to have in that market, quite rightly.

So far -- and I don't see anything which would change my opinion why the Russian government should not act pragmatically this time.

But let's see; we will have to wait until November.

Okay, thank you.

Then just a short follow-on on Australia.

Where do you see the low and superlow price segments stabilizing as a percentage of the market?

Are we looking at those continuing to rise over time or do you think that they will kind of reach a natural ceiling and then stabilize?

The prices in Australia overall -- the cigarette prices in Australia are pretty high, but I haven't seen another market of the comparable maturity when the low or superlow priced segment will take it all.

There's always medium segment.

There's always a premium segment.

Usually the market may go into polarization, so it's more the questions of the medium brands slowly being eroded by the low, superlow priced segment and the premium somehow holds its position.

Obviously in Australia we have to take it through the lenses of the plain packaging and some equity, presumably, erosion of the brands.

But I don't think it's a 0-1 game.

I don't think the whole market is going to go to the discount segment.

Thank you.

James Bushnell, Exane.

Thanks and good morning.

I have, firstly, a question on Europe, please.

Firstly, could you give a bit more detail on the price increase in Germany?

I think previously you had raised prices and then pulled one, so just how much is that and does it differ by brand at all?

And also, what do you see as the outlook for pricing in Europe as we go through the rest of the year?

Clearly, you have outlined that Italy is the drag, but what about elsewhere?

Would we expect that to improve in H2?

In Germany, the price increase was on average EUR0.20 per pack.

As you remember, Germany has various stick counts for pack sizes, the pack of 19 and the larger pack boxes, so per pack and individual SKU the price might be slightly different.

But on average, it is EUR0.20 across the portfolio in Marlboro to the low price, the lower priced L&M and Chesterfield.

When it comes to pricing, in Europe -- again, I think we should look a little bit at the pricing in Europe excluding Italy, because Italy is really dragging the price in Europe low.

And I said earlier answering I think one of the questions that the pricing impact of Italy is in the range of about -- in the tune to $100 million for the first six months of this year.

And that is significant.

You will add it back to the realized pricing and you will see that the pricing in Europe is not as being perceived by some that we -- for falling a little bit behind.

In all other markets, the pricing was taken -- a lot of pricing was taken at the beginning of the year, usually around the tax rate increases.

That is especially the case in Central Europe, Poland.

I said on the -- during remarks today we recently took also the pricing in Portugal and Spain, so I think the pricing in Europe will have to take a little bit, a different view on Italy than the rest.

Because the rest of Europe, in my opinion, is not looking as low as one would think.

Okay, thank you.

Just to come back on the Germany price increase, do I see that that is slightly different to your previous increase that was then pulled back in terms of price caps between different size packs?

Or is it the same?

No, I think it's the same, the same principle.

I hate to say -- I don't want to say it's 100% the same because maybe there is some new completely irrelevant fine-tuning on one or two SKUs by the same principle.

It's EUR0.20 across the board on average.

Okay, thank you.

My second question was just on Korea.

What, from your perspective, is the likelihood of at tax raise anytime soon?

If it is an 80% rise in average prices, which is one of the proposals that we have had, do you think that would still be good news after any short-term disruption?

Well, taking into considerations that no one almost remembers when Korea raised the tax last time I think this would be good news, but we will have to see how does it unfold.

We have heard in the past also some rumors of some initiative even to raise the taxes in Korea and this has not materialized.

So I think, myself, I am more cautious about when Korea will have a tax increase but we will have to see.

Great, thank you very much.

Michael Lavery, CLSA.

Just a few questions on Indonesia.

I'm curious with the 2% first-half category growth what -- and with the easier comparisons in the back half why you expect the deceleration to -- second half basically flat to give the 1% category growth.

Is there some kind of headwind here that you expect or consumer pressure?

How do you see that unfolding?

We see so at the beginning of the year, first half of the year some deceleration in the GDP growth, so we are always looking at the macros in order to feel more comfortable with the total industry outlook.

But I agree that the 2% year-to-date growth rate for the market versus our forecast of 1%, one could say that there is a potential for an upside.

And I would have to confirm there is a potential for an upside.

I think I need one more quarter or at least one or two more months to reconfirm that Indonesia is moving to -- the total market is moving to the better growth rate.

It is good news for us, but I think it was very clear in the remarks that, despite the fact that the market is year-to-date 2%, we still think for the 1% growth for the full year.

Then just looking at your market share, you've got the 60 basis point decline in Dji Sam Soe and the 60 basis points share from Dji Sam Soe Magnum Blue, so obviously that nets to zero.

And you've got the increase over 1 point in new mild, only slightly offset by Marlboro, but your total share is down over 1 point.

So how do we reconcile that?

Is Dji Sam Soe Magnum, the non-Blue, down pretty significantly?

No, Dji Sam Soe in the machine-made -- both Dji Sam Soe's Magnum and the Magnum Blue in the machine-made segment is actually growing as expected, very nicely.

So increasing our share in the machine-made part of the market.

Dji Sam Soe in the hand-rolled version, the challenge is, on the one hand, is consumer going to the machine-made, but the prime challenge which the brand faces this year is the price point.

It sits above the round price point what the competitors are approaching, but they are still technically slightly below that price point.

So I think in Q3 we should see that sort of a headwind for the Dji Sam Soe to being (inaudible).

One more comment, if I may.

When you look at the Marlboro share in Indonesia, this is all weighted to the total market.

The white cigarette market, the non-kretek market, and the kretek market are not necessary highly interlinked markets within the one cigarette market.

You always have sometime the fluctuations on a Marlboro share just because the total market growth, which happened last quarter, came obviously for the kretek as the main driver.

So the rate of the kretek market may sometimes give you fluctuations on a Marlboro share.

That's helpful, thanks.

Then on the handrolled price points, have you seen a better balance in how the competition looks?

I know some of those have crossed the same [value] rupiah mark, but it's a little scattered sort of regionally or by channels and things like that.

So is that looking like that's more consistent now across the competition?

No, this is as we predicted.

That there will be -- there is a time we needed when in a pricing stance in the region by region, etc., these brands or the SKU sets will go in across this price point.

So some have already reached across, some are still hanging slightly below.

I think the Q3, as we predicted initially, it's about the time when the Dji Sam Soe should have that price point pressure behind the [drug] or in front of it.

That's great.

Then just last question on Indonesia, you mentioned in the release how the optimizing production was -- contributed higher costs, but certainly it seems like if you're optimizing production that would be a better cost profile.

So is it right to assume those are one-time?

And how significant was that and is that behind you now?

Indonesia is optimization of production is essentially to manage the capacity between the hand-rolled capacity and the machine-made capacity.

So it's a little bit different than optimizations which we undertook in Australia and in Holland in particular.

Yes, that's it.

So they will have some costs associated with managing the handrolled capacity from forming the handrolled, if you like, capacity into machine-made capacity.

I guess I'm just trying to understand what that is.

Do you have an ongoing cost?

Do you just have idle factories of people making handrolled that aren't producing --?

What is the cost that hit in this quarter?

Is it a one-time plant closure cost or is it something ongoing?

Well, these are the costs associated with the downsizing so they don't really qualify into reporting adjustments.

Therefore, we have not carved it out in our reconciliation from reported to adjusted results.

They see it in our underlying numbers.

But the cost is essentially about what you need to -- unfortunately, the results were the termination of the employment of the hand rollers and they are smaller -- and creating the capacity on the machine in the factories which are producing machine-made cigarettes.

Okay, that's helpful.

So even if we keep it in the adjusted number, can you give any sense of what the magnitude is in terms of how to think about the comparison next year?

No, but what we have done is, as you remember -- not in the case of Indonesia, but if you remember, in Q1 of this year we have said that our cost associated with the closure of the plant in Australia we can get resets out of one was recorded in Q1, which was a reporting adjustment.

And the $0.02, which will kick up later on but not as a reporting adjustment.

Now I will have a boss which also I am incurring some costs which do not qualify by US GAAP rules as the reporting adjustments.

I will incur these costs this year in order to complete this project.

So in total, if I take all the projects together in my underlying results, you're talking about the $0.02 to $0.04, which I associated with the cost of a closure or adjusting the -- or factoring the footprint and the capacity optimization.

Okay, thanks.

That's helpful.

(multiple speakers) underlying.

This is not part of the reporting adjustment.

Right, okay.

And then just on the Netherlands plant closure, that is scheduled, I believe, for September 1. If that goes as planned, some of that benefit would come in fourth quarter of this year, correct?

Very small.

I don�t think -- this will not be material.

Because we need to take September 1, the limitation of the production, you obviously have inventory in the meantime, which were already produced, etc.

So this will not materially impact it.

You will pick up a full impact of that boss on the back of some restructuring next year, 2015.

So it would lag, even if the plant is closed for three or four months later this year, there wouldn�t be a tradings benefit really in 2014?

No, but I will have -- as I mentioned before, I will have also some costs associated with my closed zero bid plan, which helps me underlying results.

Net of the project, you will not see the material impact of the thing.

Actually that will be more outweighted on the call than the benefit, which I may pick up for literally a few weeks for this year.

No, that's helpful, thanks.

Then I know Australia has been covered a bit, but just one last question there if we can.

Can you just help us understand some of the dynamics?

It seems like even with plain packaging coming in, this didn't -- there wasn't any real issues over the first kind of 13 months during last year and when it started in December.

Now certainly it looks like it's a different picture in 2014.

But what started all this?

What was kind of the trigger that made the issues for you become something you would call out?

Is it directly related to plain packaging, value brand erosion happening maybe more quickly than people might have thought?

Can you just explain some of kind of what started all this?

What started -- when I start discounting was much earlier in the market than the plain packaging, so the market always was characterizing by some level of discounting, when people were essentially buying down the price for the consumer at the retail level.

What we have observed that towards the end of the last year, frankly speaking, that it was an increased discounting activity by some of our competitors.

So when we look at our share erosions, which I think was pretty visible in the first quarter, there was obvious decisions that we had to react, stay competitive, and not allow the share to further decline.

So, yes, there is obviously the element of the plain packaging in the whole thing, but I think we couldn't just attribute the current situation entirely to plain packaging.

But plain packaging, clearly, by the fact that somebody took away your trademarks, erodes the equity of my brand and it erodes the equity of my product.

So there is an element of that thing.

How much you would attribute to this, it's difficult to say at this stage.

You cannot ignore it, but this is not the only element which was -- which is happening there.

This is all in the context of very significant package increases, which took historically in the last year and also will happen this year in the market.

Because last year September you had a 12.5% extra tax increase, excise tax increase.

In September of this year we will have another 12.5% additional excise tax increase.

Is that obviously -- and the year after, so it makes a significant price -- it drives the significant price increases.

And obviously as the market already has the cigarettes at the price of average of about AUD17 for the pack of 25, of the 25 cigarettes.

You have a natural sort of a tendency to go into the down trading, which can be further fueled if you activate discounting, because you open the gap.

Maybe if you look at the market and you realize that the price gaps are in the range of an AUD6, AUD8, at that price level per pack in many other markets.

And in Australia we have the price gaps of that margin issue, obviously because the underlying prices per pack are already pretty high.

The AUD6 or AUD8 sort of the erosion in the mix is already pretty significant.

Okay, great.

Thank you very much.

Owen Bennett, Nomura.

Just a quick one.

I was just wondering on the EEMA top-line performance, how much of this was driven by the change in Egypt business structure?

How long will this benefit continue before it lapse or was it more a one-off influence in the quarter?

Thank you.

There was the impact of that, Egypt obviously, because of the business structure, but there was an underlying growth in Egypt.

The entire -- very strong quarter for the region, very much driven by the price came not only from Russia, but came from North Africa, some other markets in Egypt.

Egypt played a critical role, but this is in addition of us now reporting Egypt differently due to the business structure change this year.

Okay, thank you.

Vivien Azer, Cowen and Company.

Good morning.

In terms of the improvement in the EU, I appreciate fully that you are waiting to get the full June results before you have the confidence to raise your guidance for the region.

I was curious if you could speak to the sequential trends through the quarter and if there was any one or two key markets that really kind of drove the improved outlook relative to what you had offered at your analyst day.

Just to clarify, we don't give the guidance at the segment level, Vivien, so we are giving an outlook when it comes to total market.

Certainly.

But we will look at the June results.

The market which we -- all of the markets essentially confirmed what we've seen over the last five, six, seven months, depends on the market trends.

If you look at the total market trend, there are three markets which are today somehow lagging behind in terms of the decline rate should be better, i.e., lower, than the entire region.

One of these markets is France, so we have to watch it, but I don't think it's going to change dramatically total EU picture.

And the two other markets are relatively smaller markets, is Greece and Hungary.

So I have a free market which I wish would follow the trendline of the rest of the region, but even in absence of this I think EU, as we announced today in my remarks, EU outlook for the full year as a closer is around 5% and it's based on the sequential improvements which we saw.

Excellent.

Well, that's certainly good news.

Just to follow-up quickly on Indonesia; I appreciate why you are holding your guidance.

I think that makes a lot of sense.

I was curious whether embedded in that was an outlook for any change in the fuel subsidy.

I know we are still waiting to see how the presidential election unfolds as they count the ballots, but it does seem like that might be a reality in that market very late into 2014.

To my recollections there is not much.

I haven't -- I don't really recall there was discussions about any changes to the fuel subsidies recently, unless I have missed something, but I don't think so.

On the presidential elections, all fine and we will have to see how does it unfold and what's the new direction, political direction there.

I was much more -- we are much more looking into the GDP development, the pricing development, etc., and based on this we are trying, to the best of our knowledge, to estimate the market growth.

But as I indicated a moment before, I do admit that with a 2% year-to-date our 1% outlook is maybe too cautious, but we will have to see.

This market is a market which has a lot of stick sales.

The levels of sales and the consumptions can pretty rapidly change in these places so we will have to see.

Yes, that makes sense.

Lastly, maybe it is still too early, but I was wondering whether you wanted -- could offer any commentary.

As you go into your city tests on the iQOS, can you dimensionalize for us how you are thinking about the pricing of the iQOS system relative to other competitive novel tobacco systems in their respective markets of Japan and Italy?

You know me; I am a great fan of iQOS.

I am using this product.

I wish I could share this with you, but I can�t.

Fair enough.

One thing when we talk about the iQOS, which is also to explain a little bit our cost variance this year -- and I know that I am bridging from your questions to something else, but it is important to remember that the two test markets on iQOS will happen in Q4 this year.

This obviously will contribute one of the contributed elements: when we will have a less favorable cost toward the end of the year versus the previous period -- previous year.

That makes perfect sense.

Thank you very much.

Adam Spielman, Citi.

Thank you very much for taking the question.

Good morning.

It is a question about Italy and the outlook for changes in the tax situation there.

Now, I believe or I have seen that there was an announcement, I think in the last day or two, of what I believe is a very small increase in tax, but an increase nonetheless.

I was wondering, first of all, if you could just confirm that I'm right that it's pretty marginal.

And secondly, and perhaps more importantly, to comment if you can about how you think and when you think there will be a substantial change in the tax situation in Italy.

Thank you.

You are absolutely right.

There was a very small almost cosmetic sort of a change, which resulted in I think a 0.1 -- not I think, I know it's a 0.1 incident increase.

They increased the specific -- the minimum excise tax on cigarettes by EUR1 and the minimum excise tax on the fine cut product by EUR3.

So there is some sort of a legacy coming from still last year and just Italy was pretty late in translating this into the tax rate.

This has nothing to do with the tax restructuring, which in our understanding is that the government is debating as we speak.

So we will see how does it unfold.

I think there are a number of people who are recognizing that the tax structure, which Italy has today is pretty archaic.

It doesn't stand the market requirements, both on the governmental revenue side, very much on the governmental revenue side, but also on the overall market.

When would you expect to have news on a substantial reform?

Well, because it is Italy, the expectations with regards to time you have pretty flexible.

Okay.

But this calendar year, I guess?

As I said, it's Italy, so we will have to be (multiple speakers).

Eric Bloomquist, Berenberg.

Thanks for taking that.

I was actually -- I had the same question as Adam so I am all sorted, thank you.

I will give the same answer I guess.

At this time we have no further questions.

I would like to turn the floor back over to Nick for any additional or closing remarks.

Thank you very much.

Thank you all for joining us.

That concludes our call for today.