菲利普莫里斯國際 (PM) 2015 Q2 法說會逐字稿

Good day and welcome to the Philip Morris International second-quarter 2015 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 2015 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 of 2015, comparing them to the same period in 2014 unless otherwise stated.

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

Reduced-Risk Products, or RRPs, is the term we use to refer to products with the potential to reduce individual risk and population harm in comparison to smoking combustible cigarettes.

Today's remarks contained 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 Jacek Olczak, our Chief Financial Officer.

Jacek?

Thank you, Nick; and welcome, ladies and gentlemen.

Our excellent start to the year was reinforced in the second quarter.

Organic cigarette volume was strong, declining by a modest 1.4% due to lower cigarette industry volume across all regions, partly offset by marketshare gains in Asia, EEMA, and Latin America & Canada regions.

On a June year-to-date basis, our organic cigarette volume was essentially flat, or down by approximately 1% excluding inventory movements.

For 2015, we forecast an organic cigarette volume decline in the range of 1% to 1.5%.

Net revenues and adjusted OCI in the quarter were up by 4.5% and 6.1%, respectively, excluding currency and acquisitions.

This growth was driven by strong pricing across all regions, partially offset by lower volume, largely in the Asia and EU regions.

Adjusted diluted EPS, excluding currency, grew by 9.2% to $1.54.

June year-to-date adjusted diluted EPS grew by 15.8%, excluding currency.

This growth benefited from a gain in Korea related to inventories built ahead of the excise tax increase effective January 2015.

As announced in our earnings release this morning, we are reaffirming our 2015 reported diluted EPS guidance at prevailing exchange rates to be in a range of $4.32 to $4.42.

Our guidance includes a full-year unfavorable currency impact of approximately $1.15 per share at prevailing exchange rates.

Excluding currency, our 2015 guidance continues to represent a growth rate of 9% to 11% compared to our adjusted diluted EPS of $5.02 in 2014.

Given our better-than-anticipated volume and marketshare performance, we now expect to be towards the upper end of this range.

As previously communicated, our guidance includes incremental investment during the second half of the year to support the deployment of iQOS in Japan, Italy, and additional 2015 launch markets.

Our guidance now also includes accelerated spending in the fourth quarter behind planned iQOS launches in 2016 as well as incremental marketing investments in the second half to further reinforce the favorable momentum of our combustible business.

As discussed in today's press release, our guidance excludes the potential impact of a motion that is currently before the Quebec Court of Appeal related to a judgment involving the two class actions against our Canadian affiliate, Rothmans, Benson & Hedges.

Should the Court of Appeal denied the motion, PMI expects to incur an after-tax charge of approximately $0.09 per share in the second quarter, which would have a corresponding impact on our 2015 reported diluted EPS guidance.

Separately, RBH's appeal on the merits of the case is pending before the appellate court.

Although the total estimated unfavorable currency impact on our current guidance remains unchanged versus our April guidance, there has been a shift since then in its composition.

As you can see on this chart, the positive impact of the euro has been offset notably by the unfavorable impact of the Russian ruble.

Strong pricing (technical difficulty) of our financial performance.

In the second quarter, we recorded a variance of $514 million reflecting higher pricing across all four regions.

We increased retail prices during the quarter in key markets such as Argentina, Germany, Indonesia, and Russia.

Our June year-to-date pricing variance of $1.1 billion leaves us well positioned to achieve a full-year pricing broadly in line with our historical annual average of approximately $1.8 billion.

As a reminder, our first-half pricing variance includes the gain in Korea that I discussed earlier.

Our results in the quarter were underpinned by continued marketshare gains.

Share in our top 30 OCI markets grew by 0.1 point to 37.5%, with our share up or essentially flat in 17 of these markets.

Our share performance was supported by the strength of our leading brand portfolio, which continues to benefit from the rollout of our new commercial approach.

The integration of marketing and sales expertise, increased consumer focus, and field salesforce empowerment are proving to be a competitive advantage.

Importantly, Marlboro was a key contributor to our share growth.

The brand's international share, excluding China and the US, increased by 0.3 points to 9.5%.

This performance was broad-based with share up in all four regions.

Marlboro's share benefited from the further rollout of the new 2.0 Architecture, which was introduced in some 20 additional markets during the quarter, predominantly in the EEMA Region.

By year-end, we expect to have rolled out Marlboro 2.0 in approximately 100 markets.

I will now provide an update on selected geographies, beginning with the EU Region.

Cigarette industry volume in the second quarter declined by 3%, or 2.3% excluding trade inventory movements.

Consequently, we now expect a decline of 3% to 3.5% for the full year, versus our previous forecast of approximately 4%.

Our new forecast reflects improving macroeconomic conditions and moderation in the level of illicit trade, less out-switching to finecut products, and a lower prevalence of e-vapor products.

The moderation in the level of illicit trade in the quarter is consistent with the findings of an annual study published by KPMG in May.

It concluded that the consumption of counterfeit and contraband products declined in 2014 across most EU markets, with France and the UK being notable exceptions.

While our cigarette market share for the EU Region was stable at 40.4% in the second quarter, our top three brands, Marlboro, L&M, and Chesterfield, all gained share.

Marlboro's cigarette share was up in four of the top six largest markets by industry volume, with particularly strong growth in Germany and Spain.

However, Marlboro's share declined in Italy following the brand's move about the EUR5 per pack retail price point during the first quarter.

Adjusted OCI grew by 4.9% in the quarter, excluding currency and acquisitions, driven by strong pricing, which more than offset our cigarette volume decline due to a lower total market.

Turning now to Russia, the decline in cigarette industry volume decelerated to 4.2% in the quarter, resulting in a June year-to-date decrease of 6.5%.

We now expect a full-year decline towards the lower end of our 8% to 10% forecast range.

However, the economic environment remains fragile, and we are witnessing some signs of down-trading to the low-price segment.

Our excellent performance in this important market continued in the quarter.

We recorded a May quarter-to-date share gain of 0.8 points to reach 27.6%, driven notably by above-premium Parliament, as well as low-price Bond Street and super-low Next, both of which also benefited from wider distribution in the eastern part of the country.

Our cigarette volume grew by 5.3% in the quarter.

The combination of the volume increase and higher unit margins, driven by significant retail price increases, resulted in strong double-digit OCI growth in the quarter, excluding currency.

I will now cover selected markets in our Asia Region, beginning with Indonesia.

Cigarette industry volume declined by 4.6% in the quarter, following strong first-quarter growth of 6%.

On a June year-to-date basis, industry volume increased by 0.4%.

The shift in adult smokers' preferences from hand-rolled to machine-made kretek cigarettes continued in the second quarter, with the expansion of the overall machine-made kretek segment driven by the accelerated share growth of full-flavor products.

The segment share of lighter-tasting products declined slightly.

Our marketshare increased by 0.5 points to 35.2%, despite our relatively high exposure to the declining hand-rolled kretek segment.

This share growth was led by Dji Sam Soe Magnum, which helped drive a 2.5 point increase in our share of the machine-made full-flavor kretek segment and Sampoerna A, our leading machine-made lighter-tasting kretek brand.

During the quarter, we further realigned our production from hand-rolled to machine-made kretek cigarettes.

While this had an adverse impact on the Asia Region's costs in the quarter, it should provide an operational foundation better suited for long-term growth.

Over the mid- to long-term, we expect cigarette industry volume to increase within a range of 1% to 3% annually, driven by the growing adult population and rising income levels.

We forecast growth towards the lower end of this range in 2015 due to the recent softening of the economic environment.

As announced last month, Sampoerna will explore options to comply with the Indonesian Stock Exchange's mandatory requirement of 7.5% minimum public shareholding by January 30, 2016.

These include potential capital market transactions.

In Japan, cigarette industry volume increased by 11% in the quarter, due to the timing of retail trade inventory movements related to the April 2014 tax-driven price increases.

However, industry volume declined by 1.7% excluding this distortion, and by 2.6% on a June year-to-date basis, consistent with our forecast for a full-year decline of 2.5% to 3%.

Our market share declined by 1 point in the quarter to 25.4%, though it was down by a more modest 0.4 points after adjusting for inventory movements.

We continue to invest behind our brands and for 2015 expect our share to be broadly in line with last year's level.

We are supporting the Marlboro 2.0 Architecture, which we began rolling out at the end of March, and also investing behind our strong pipeline of innovation as highlighted by the recent launch of two Lark variants in the rapidly growing new taste menthol segment.

In the Philippines, the competitive environment continued to improve during the quarter, benefiting from the introduction of tax stamps.

Smoking prevalence remained stable in the quarter; however, average daily consumption declined due to higher retail prices, although it did not deteriorate on a sequential basis compared to the first quarter.

This indicates that adult smokers have largely adjusted to higher prices at the bottom of the market.

While our marketshare declined due to higher estimated duty-paid volume by our principal local competitor, Marlboro's share increased by 2.1 points to 20.2%.

The brand benefited from improved price gaps, which helped drive a volume increase of 18.1%.

As a result of the improved competitive environment and the excellent performance of Marlboro, we're increasingly optimistic about the OCI outlook for the Philippines and are expecting strong growth this year, excluding currency.

Turning now to our RRP portfolio, we will commence the national expansion of iQOS in Japan this September.

Building on the success of our pilot launch in Nagoya, iQOS will be rolled out in key regions at a price of JP why JPY9,980, or approximately $80.

The rollout will feature an upgraded version of iQOS in new colors and textures, to broaden its appeal among adult smokers.

Our expansion plan for Italy also remains on track, with additional city launches commencing later this year.

I am also extremely pleased to announce the launch of iQOS in Switzerland this August.

The launch will focus on five major cities with retail distribution in approximately 250 outlets by the end of October.

The iQOS kit will feature the upgraded version of iQOS, while Marlboro's HeatSticks will be available in regular, smooth, and menthol variants.

On our e-commerce platform, the kit will have a retail price of CHF80, or approximately $85, and HeatSticks will retail with a premium positioning at CHF8 per pack of 20.

We generated free cash flow of $2.9 billion in the first half of the year.

This was in line with our free cash flow for the first half of 2014, despite an adverse currency impact of $1.6 billion.

Our resilient cash flow performance was supported by prudent cash flow management, particularly with regard to working capital and capital expenditures.

For 2015, we forecast free cash flow to be broadly in line with last year's level, despite the significant currency headwind.

In conclusion, our excellent start to the year was reinforced in the second quarter, with a modest organic cigarette volume decline and a strong currency-neutral financial result driven by robust business fundamentals.

In the combustible business, our superior brand portfolio, supported by a superb commercial organization, is driving strong pricing and continued marketshare gains.

Meanwhile, our iQOS pilot launches are performing well; we're on track with further rollouts in Japan and Italy and will soon be launching the product in Switzerland.

We remain committed to returning around 100% of our free cash flow to shareholders.

As of last Friday's market close, our dividend yield of 4.9% was significantly above that of our tobacco peer group and 10-year U.S. Treasury notes.

On a currency-neutral basis, our 2015 EPS guidance reflects a growth rate of 9% to 11% versus 2014 adjusted diluted EPS of $5.02.

Given our better-than-anticipated performance, we now expect to be towards the upper end of this range.

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

(Operator Instructions) Judy Hong, Goldman Sachs.

Thank you.

Hi, Jacek.

So, first, I guess if we think about your guidance for the full year, you're thinking the FX-neutral earnings growth is coming in at the upper end of the range.

Obviously, the first half has been pretty strong; so it sounds like maybe there is some incremental spending that you've called out around the iQOS as well as the combustibles.

So is there a way to quantify some of that incremental spending beyond what you had anticipated at the beginning of the year?

And then, what is prompting some of that incremental spending both on the iQOS side and then on the combustible side?

Look, Judy, clearly as I said in my remarks there is incremental spending by accelerating some 2016 launches of iQOS towards the beginning of the year; hence we have to ramp up the infrastructure already in preparations already this year as we're increasing the investment behind the combustible business.

But as you have noted, it will have a very strong share growth momentum in a number of markets behind Marlboro and other international brands; so we think it's just the right time to further support the performance of this brand.

And, frankly speaking, we slowly start looking more already into the 2016.

We've had -- since then we will have a very strong 2015, trying to maintain that momentum going forward.

I will -- you have to excuse me, but I would rather not quantify how much is the next (inaudible); but clearly it would be above our guidance absent this additional investment.

Okay.

Then just in the second quarter the margins in Asia came in a little bit softer; and I think underlying FX-neutral earnings or operating income growth was down a little bit, which I guess is a little bit surprising given the strong volume performance that you had in Japan.

I know you cited the Indonesia distribution expenses.

Can you just talk about the puts and takes in terms of the second-quarter Asia margins?

And is the Indonesia cost increases one-time for the quarter, or is this continuation into the next few quarters?

In Indonesia specifically, we had extra expenses in Q2 connecting with a reallocating of the capacity between hand-rolled facilities and the machine-made facilities.

So this is more of the sort of the one-timer.

But this clearly hits the entire Asia Region when it comes to the profit margins and overall profitability.

I think for the full year, Asia clearly will have a much better performance than we had last year.

But last year, Asia had a pretty, I could say, a low, a lousy performance, okay?

But Asia is heading towards the mid to -- is approaching the mid- to long-term growth target.

They may miss it by a bit, but I think Asia overall is looking good going forward for the full year.

Okay.

Then last question, just the Sampoerna decision that I guess you're looking at in terms of some of the capital market transaction potentially.

Can you just help us, how you're thinking about some of that decision?

And to the extent that there is additional cash flow that comes in with that transaction, would you think about that giving you some cushion to raise a dividend and start resuming the share buyback?

Well, first we need to make the decision which avenue actually we're finally pursuing in Indonesia.

But -- so I will park for a moment the question how we will distribute the eventual proceeds from the transaction, if the transactions happen.

I will just pose that question -- park that question for later.

As you know there is, on the one hand, the requirement to have a public float of 7.5%.

We're clearly below the 7.5%.

On the other hand, you have squeeze-out rules which are not necessarily the most effective.

There is somehow in between those two parameters we will have to make our decision.

But I will just -- we have to wait some time until we conclude what is the best option for the Company and the shareholders.

Okay, thank you.

Vivien Azer, Cowen and Company.

Hi, good morning.

My first question has to do with your outlook on pricing.

Clearly it's been incredibly robust in the first half of the year; and you noted the benefit of Korea.

But as I look to the back have, given how much pricing you've already realized, are there any other callouts in terms of you guys ending up realizing pricing roughly in line with your historical average?

Because right now it would look like you would be tracking ahead of that.

We might come slightly above the historical average; therefore, the language which we use they will be broadly in line.

So don't hold me by a $10 million or $20 million or $30 million.

But I think we're looking into the strong pricing for this year; but overall, pricing environment, with the tax and the volumes, total industry volumes, I think are playing on our side.

So yes, we're looking for the strong pricing for this year.

That's very helpful.

Thank you.

My second question has to do with Russia.

While it's encouraging to hear that you think volumes will come in at the better end of that range, I guess the offset being the down-trading.

It feels to me like the down-trading has been at play for a while given the outsized volume gains that you've seen for your lower-priced brands.

So could you elaborate on that comment a little bit?

Are you seeing down-trading accelerating?

Is that coincident with the second price increase having hit?

Any other color I think would be helpful.

I think it's -- look, until the Q1 I remember the same question was being asked at that time.

I said that we don't really observe much of a down-trading or down-trading at all in Russia.

As you turned into Q2, yes, there was a pricing which was hitting the market in between.

Yes, you could see that the market somehow consolidates in the middle.

I mean, the super-super-low price segments are losing; the low price is gaining; the premium is slightly losing.

So yes, you have a down-trading.

We always had Russia on the watch-out list due to the underlying macros and the overall sentiment, etc.

The good news is the Russian volumes.

I mean, it seems that we are confronted with a bit better price elasticities which we initially assumed; hence our revision that more likely or most likely Russia will end the year with about 8% or closer to 8% industry volume decline versus the initial range of 8% to 10%.

The volumes for the year to date are pretty strong, taking into consideration the overall market situations and pricing taken.

So yes, the down-trading is -- we start seeing.

Now, it's not really a big surprise because Russia operates with a -- compared to many matured markets -- with pretty wide price gaps.

The gap between a premium and a low-price cigarette are much higher than what you, for example, see in a Western or in the European Union.

So yes, there is some room for the consumers to at least temporary mitigate some of the macro headwinds by hopefully temporarily going to the lower-priced segment.

But remember, Russia is one of the markets when you see the down-trading if macros are a little bit weaker, situations improve we could see the up-trading.

Good news for us is that I think portfolio-wise -- and I think this was supported by the performance of our two or three brands.

Both Bonds and Next, Bond Street and Next at the bottom of the market; and premium Parliament -- or above-premium Parliament, which all three brands are gaining share.

So portfolio-wise, we're okay.

We still have to continue watching how Russia unfolds in terms of the dynamics between price segments.

That's very helpful.

Thank you very much.

Matthew Grainger, Morgan Stanley.

Thanks.

Hi, Jacek.

I just had two questions.

First, within EEMA, results were obviously still quite good on an overall basis, given all the volatility in the region.

But I noticed that price/mix and OCI growth were both a bit below trend.

Typically we've seen them growing at a double-digit rate.

So what factors could you call out that may have contributed to the more moderate rate of growth in the quarter?

Well, I think the pricing was coming stronger as plan.

I think slightly presumably will have an impact of some sort of a mix, partially driven by Russia, okay?

So this is what it is.

But overall I think EEMA is -- and Russia in particular -- we are expecting a very strong performance this year for the full year, both Russia and EEMA.

I mean, the other locations, other geographies in EEMA which have a strong performance, North Africa, I mean a few others.

So I think we feel positive on the outlook for this year for EEMA.

Okay.

Thanks.

And second question, just on iQOS in Switzerland: can you talk a little bit more about the determination of the price point for the HeatSticks themselves?

And just at a broader level, what have your learnings been from Italy and Japan on relative price points?

How does the retail price of CHF8 compare to a comparable pack of Marlboro cigarettes?

Do we have any clarity on the tax treatment?

Marlboro HeatSticks for the pack of 20, slightly below the Marlboro.

Marlboro I think is at CHF8.50.

We decided to go in this market for a Marlboro of [CHF8].

We have a tax clarification.

And as in Japan and Italy, iQOS HeatSticks are not classified as a cigarette product, and hence will enjoy the lower taxation than the combustible cigarette.

Okay, that's great.

Thanks, Jacek.

Bonnie Herzog, Wells Fargo.

Hi, Jacek.

I guess I was hoping you could drill down a little more on your Marlboro Architecture, since you've seen such a positive impact from Marlboro 2.0 in several markets.

And then could you give us an idea which particular markets you feel there could be even more upside potential?

Look, we're rolling as we speak Marlboro 2.0 in the additional markets.

As I said by year-end we should see the mark of about 100 markets.

So that essentially almost covers most of our important geographies.

It's well received.

I think if you look at the performance of Marlboro in Germany, I think it clearly is an impact of Marlboro 2.0.

I think I would say that performance in Germany actually goes above our expectations.

And if I look at the demographics, how we managed to change the demographic behind the Marlboros, it's not just the marketshare current, but also how the demographics augers well for the future of Marlboro.

I mean Germany would be one of that markets that we can see the further upside.

But in general, in essentially all geographies Marlboro, the new supports, also connected with the commercial approach, etc., I mean it yields the results.

No, that's a good point.

And you mentioned Germany because clearly it's done very well.

So how realistic do you think it would be to assume the performance that you've seen there could be replicated in some of the other key markets?

Well, it is being replicated.

I mean it might be not to that extent as in Germany; but overall if I look at changing demographics behind the Marlboro, the LA-24 share, the values of Marlboro, how Marlboro resonates more on being dynamic, innovative sort of a brand, I mean this qualitative assessment of the Marlboro is by far better in essentially all geographies when we launched at [ramp].

I can't find in my memory a market which we wouldn't move this way.

Now marketshare performance in a current period from place to place may also be impacted by the -- given price situations.

I would call out, for example, Mexico, right, when -- yes, there is a bit of a down-trading in the market.

There are some pricing pressures at the bottom of the market, so you might have a temporary brand share erosion.

But what we really focus on is to making sure that the underlying demographics behind the brands are getting better.

Because this really -- once the pricing is unlocked or solved, that really will support or should support the further growth of the brand.

So even in the market where Marlboro has a little bit of a share pressure, within a premium segment Marlboro actually is doing -- is performing very strongly.

It's gaining share.

Okay, that's helpful.

Then, Jacek, you guys announced the extension of your strategic framework with Altria Group; so what do you think the biggest benefits will be?

For instance, could it be the acceleration of the pace that you're bringing new products to market and/or increasing the number of new products?

And then maybe could you give us an idea of how much your investments behind Reduced-Risk Products broadly could increase as a result of this extended framework?

Well, we've had the existing, as you remember, agreement with Altria on the current generation of e-cigarette product.

And this agreement essentially will focus both companies -- will take both companies' focus behind the new generation of a cigarette focus.

I think Altria is bringing to the table quite a knowledge of the existing products and other critical components.

We have our own research, our own discoveries, our own fruits of the investment through R&D.

And I think it makes good sense for both companies from the results management to pool their resources together and work further jointly on the new generation.

I think logically this should result in acceleration of a development of a new generation cigarette product.

And, hence obviously, both of us, both companies could be in their respective markets faster in addressing the consumer needs.

You will appreciate I wouldn't say how much in terms of a financial investment this require, for obvious reasons.

Okay, thank you.

Michael Lavery, CLSA.

Good morning.

Whether or not -- regardless of what the Indonesia transaction does or doesn't look like, could you give a little sense of how you think about resuming buybacks and if there is any metrics you are looking for, or if you would want to see a turn in currency for maybe even a little bit of time, if you are eager to try to get back to it, or if you want to be more cautious and have some cushion on the balance sheet?

What's the way that you frame that internally?

Well, look, if we're looking into a sustainable share buyback program, we clearly have to go back to what took us out of the share buyback program currently.

And that clearly is the big headwind which we get from the currency.

We have made it very clear that underlying business performance, whether you look at the top line, bottom line, etc., and the cash flow generation is coming very -- is very strong.

I mean, the currency is essentially sending our credit metrics at the edge of our current credit rating, and therefore we had to suspend it.

So it's the currency which is the main culprit behind the absence of a share buyback program this year.

So we will have to see the improvement on a currency front from this side.

Okay, that's helpful.

Thank you.

And then just on iQOS, you've completed some clinical studies recently.

On the national rollouts in Japan, in Italy, and then also in the launch in Switzerland, is there any health claim associated with those that you are making on the product?

Not a health claim, but I think we're moving slowly into making the reduced exposure claims; and this is also the result of the six short-term clinical studies, which have been completed as per plan.

And the study results, they show a substantial reduction in the relevant biomarkers of exposure in adult consumers who switch to iQOS; and this is compared, obviously, to adult consumers who continue to smoke conventional cigarettes.

We have the results of the studies, and I believe part of our communications in this location and other locations which we have not disclosed yet will have a component of the reduced exposure claims.

So just to clarify -- maybe my word choice was a little off saying health claim; but you are making a reduced risk or reduced exposure claim associated with it?

They are two different things, reduced risk and reduced exposure.

Reduced exposure we base on the knowledge which we have today, based on the results of the clinical studies, etc.

I think we're getting into positions that we can make a reduced exposure claims.

Reduced risk claims I think it's more of the story of the 2016, and depends on the regulatory framework in the countries in which we will be launching iQOS.

Okay, thanks.

Then just on Australia, could you give an update on what the pricing environment is looking like there and if pricing from the latest round is sticking, or if there is any more promotional intensity?

I guess specifically, too, in the last quarter's call you said it was looking like less of a drag -- if even a maybe a drag at all -- this year.

Is that still your view, or could you give any update on how you're thinking about that market?

I mean, we had the pricing in the beginning of Q2; it somehow sticks.

It's not maybe the sort of the perfections you would like to see, but maybe life is not perfect.

We have to live with what we have.

It's clear Australia is much less, if at all, the drag this year that it used to be for us last year.

And I think that's also the outlook for the full year.

We'll have all the September tax price, hopefully price change as well, and we'll see how this unfolds.

You have -- somehow the down-trading I think in the market is a little bit slightly better; but it's not really something which I think at this stage would put us into jeopardy in terms of our total PMI performance for the full year.

But it's vastly better than last year.

But we would like to grow the profitability in this market rather than just on a comp basis be better than last year.

No, that's helpful.

Thanks.

Just one quick last one in the Philippines.

Have you seen any impact from the launch of Chesterfield and L&M?

Is that becoming a meaningful part of that portfolio, or is it still early?

Well, hopeful -- this is still early.

I think the early results are good, but that's a bit of the longer run.

We're clearly building a portfolio to reflect the current market reality dynamics, etc.

If I can just extrapolate -- and I think I have a good reason to extrapolate -- of Chesterfield's performance from other international markets in which we activate, that brand should do properly its designed job in the Philippines market as well.

But it's too early at this stage to start looking.

Still Marlboro, what is very important, grows very strongly the share and the volumes.

And that's great, because this is what is a good reflection of the strength of the Marlboro and obviously reaction to the lower price gaps.

Fortune is not doing that bad.

It's quite a lot of initiatives about our second brand which we have there, Fortune; and I think this brand also has a great future going forward.

And I think Chesterfield, L&M are the brands which will maybe initially complement the portfolio, and maybe one day they're going to play a more significant role in the overall portfolio.

Okay.

Yes, that's great.

Thank you very much.

Chris Growe, Stifel.

Hi, good morning.

I just had two questions for you if I could.

A bit of a follow-on to one of Michael's questions there.

In relation to -- there is a common of returning 100% of the cash flow to investors.

So I'm just curious.

You've had a pretty strong operating cash flow performance this year, some working capital improvements.

As you -- what's the -- is it a 2 times debt-to-EBITDA target you're targeting here?

And therefore, incremental cash flow if there is better working capital control, is that just going towards debt reduction in the short run like we saw this quarter?

No.

I mean, with the credit rating which we're shooting at is about a 2.5, right?

Because this is what is allowed for our credit rating.

The cash, if we deliver the free cash flow for this year broadly, we've aligned with the last year.

Last year was about $6.5 billion, slightly above the $6.5 billion.

That's a nice cushion to have versus the dividend commitment which currently stands at about $6.1 billion, $6.2 billion.

So this is how we're looking at that thing.

We want to have a nice cushion above the current -- dividend at the current level.

Okay.

Then I have one other question if I could, please.

On your -- the facility to make your Reduced-Risk Products in Italy, is that completed in the third quarter?

Is that going to be like fully operational?

And then should we expect around Q3 to hear about more markets in which you're going to begin launching that product?

I think the structures, etc., are completed or about to be completed, and we're now moving to the installings and equipment, to the machinery.

So I think it all goes as per plan.

As we said the capacity from that you need in addition to the [training] center, which is producing the initial 5 billion capacity, should be available as of 2016.

So very shortly we should have an access to the incremental capacity coming from this factory.

Okay.

Thank you for your time.

Bill Marshall, Barclays.

Good morning.

Just curious, first, I was wondering if you could just expand a little bit on the decision to dissolve the JV with Swedish Match?

And looking at that I would imagine that over time your emphasis around that portfolio of snus and smokeless would come down.

Is that an ability to rotate some of those resources back towards your existing business?

Well, the mutual decision about dissolving the joint venture with Swedish Match was based on the fact that, yes, there is some potential for some product in some geographies as we made progress.

But I guess by standards, our standards, that progress -- under both companies, the progress was slow.

So we just decided that maybe it's better that both companies would just pursue their own growth opportunities, and this is how we reached a decision of dissolving.

Swedish Match -- sorry, the joint venture with Swedish Match didn't have a material impact on our financials; so I wouldn't count on any material reallocation of resources from our Swedish Match joint venture to PMI.

Great, thank you.

Then just also more of a housekeeping item.

You laid out pretty detailed foreign-currency impact in each of the individual currencies.

In the past, you've talked a little bit about hedging, particularly on the yen, from a transaction perspective.

I was curious if you could give us an update on any currencies that you were hedged on, like the yen, and at what levels and for what duration?

Well, we are above a 60% for this year; but we would like to remind everyone that our financial policy is that we constantly look at the 12, 18 months ahead.

So it's fair to assume that we already start hedging our yen cash flows for 2016.

When we'll be giving -- as was always the practice tradition -- the guidance for the 2016 in February, we will update you on the number what is our current hedge ratio for the 2016.

But as I said, we are already looking into 2016.

And, yes, that's it essentially.

Great.

Thank you very much.

James Bushnell, Exane.

Thank you and good morning.

I had a couple of questions.

My first one was just a follow-up on the snus question.

Was just interested in whether we should read anything into PMI's philosophy towards snus.

Do you see it as part of the reduced-risk complex and therefore well worth exploring in a number of places?

Or is it more do you see it as a niche for a few select markets?

How are you thinking about that product for the moment?

I think from a reduced perspective, snus clearly has a potential.

From a consumer acceptance perspective, based on our experience in a few geographies when the joint venture had launched the products and commercialized the product, that seems that this is a longer shot, that we were thinking.

Okay?

This is how I would look at this.

Okay, great.

Thank you.

My second question was about Poland.

I think volumes are down on the market level about 5%, which might not sound that great, but I think it's the least-bad read you've had there for a while.

I just wondered if there is anything changing there for the better.

And if you could just generally describe the dynamics, that would be useful.

No, Poland is one of the countries which we should still observe, like in many other European Union geographies, better or improved situations with regards to illicit trade.

As you know, Poland is in between the East and the West, so it's always more difficult to maybe keep these things under controls there.

But I know that the government is focused on addressing the illicit trade.

It also addresses their budgetary needs.

Volumes, you rightly note, is getting better.

But compared to many other markets in the European Union, I still would like to see the Polish volume -- total market volumes getting better.

Our share is great.

The brands are performing great.

So on a business side, we're now seeing great shape in Poland.

But our market still I think has room to improve.

But we will have to see when it's going to happen.

Okay.

Thank you.

Just one last question on iQOS.

How is the retention rate of consumers who try iQOS progressing in Japan and Italy?

And also just as a very small technical point, did I hear you right that Marlboro cigarettes are priced at CHF8.50 in Switzerland and the HeatSticks are just below that?

Or did I get that the wrong way around?

Thank you.

Yes, you're correct; it's slightly priced below Marlboro in Switzerland.

In terms of -- with regard to the retention rate, they're broadly the same as we had been in Q1; but frankly speaking, we have spent more of the Q2 time in the test markets to changing, if you like, some component of our marketing mix, etc., in preparations of the national rollout.

But as I said already in Q1, it's about one-third of those who have purchased, really purchase iQOS device, about one-third has is predominantly using an iQOS.

And there is a significant group of the consumer who is somehow in a transition.

Great.

Thank you.

Sorry, just one cheeky follow-up.

What is the difference in the new iQOS device versus the old one?

It's better look, better functionality, better feel and touch.

We addressed some of the feedbacks we received from the consumers with regards to the electronics and operations of the electronics.

So we're being able to fit it into the new device.

It's really a new, better iQOS.

Okay, great.

Thank you very much.

Erik Bloomquist, Berenberg.

Hi, good afternoon, Jacek.

I thought your comment with respect to the contributions to European volume was interesting.

Is there a way that you could break apart for us the contributions of the reduction in illicit and in e-vapor?

In aggregate are those worth about 1% to European Union volumes?

Or is there pricing offsetting some of that benefit, so the reduction in those is actually a bit greater?

Well, there is a pricing in Europe which is ahead of the -- or higher than the pricing we used to have in the first half of the last year.

But -- so yes, there is some impact on volumes.

But on the other hand, I think the underlying macros in many European markets or consumer sentiment is somehow helping us with a better elasticities that we would -- which we remember from a 2012, 2013 period.

I think -- I mean, there is not exact math how much is coming from the illicit trade, because you will have to go from market to market.

I think a contribution from illicit trade to the German volume is presumably higher; contribution of illicit trade in some other places might be the difference.

E-vapor products, they didn't contribute that much in Germany because this was not really any sizable sort of a category.

But I think they're more helping France or Spain or other geographies.

One thing which we also have to remember, we observed a very serious slowdown in the dynamics of the finecut or [other] tobacco products, which is also the outcome of a tax and price, and I guess also the better consumer sort of a sentiment.

You remember this is a category which used to grow say 2012, 2013 in the tune of 6% to 7% per annual; and these volumes now are growing, I think, around 1% max.

So you could see the drastic change in the dynamics, which obviously was pushing or pulling the consumers from the manufactured cigarettes to the finecut product much stronger in the past that we see now.

I mean, I can't give you the number how much each of these on the total -- of these drivers on a total EU basis contributed.

I think we will have to go market by market and put some weight, where is more of the weight, where is less of the weight, which helps the total market performance.

But look, let's enjoy the good total market performance.

We know what are the drivers; we've been looking that finally one day all these things which were the significant headwind for us will unwind, and will start converting into tailwinds, and hope this is a more sustainable trend for the [EU].

Okay.

Then also related to the European vapor market, does the imposition of the Tobacco Products Directive, does that also then create a bit of a headwind for that particular market?

And is it really something that probably advantages the Marlboro iQOS and HeatSticks system, given that you are already able to bring the product -- it already has a set regulatory environment, whereas the TPD imposition will arguably make more things more difficult for vapor?

Is that something that you could expand on, please?

Well, I mean, everything depends obviously how TPD is going to be transposed into the member states' legislation, and that's the process which started.

There are some member states which already are advanced; there are some member states which still are before the parliamentary etc.

discussion.

The deadline, as we know, is May 2016.

We will be in a position to say how individual member states -- what sort of a framework they create for both the novel tobacco product and the e-cigarettes.

As you remember, in TPD there is a distinction between both, group of both categories.

Then we'll see how that's going to play out.

Okay.

Then lastly on the TPD with respect to Philip Morris's litigation against it, can you give us an update on where things stand and when we may the next set of news flow on that, what the progress is in terms of challenging TPD 2?

Well, it's not much really of a development which happened, right?

I mean, the JT case in Ireland was retained in Ireland, which I think is a good news because it will otherwise result in a clash of two similar, if you like, cases at ECJ level.

I think it's fair to assume that ECJ, because I think it's the most important part of a challenge against the directive, that ECJ -- which will reach the European Court of Justice, or it will reach the conclusion before the due date for the transposition implementation of the directive, which I said earlier is May 2016.

And that's it, essentially.

Okay.

Thank you.

Owen Bennett, Nomura.

Morning, Jacek.

Just a couple of questions, please.

Firstly, and just on LatAm, other than the pricing leverage, I was just wondering what was driving the very strong margins there and how sustainable these are into the rest of the year?

Then secondly, just on some industry volumes, could you give an update on guidance for South Korea for the year now?

And also possibly if you could comment on how industry volumes are trending in Australia, especially with the recent price increases; thank you.

Okay.

So, on LAC I think we had a strong pricing coming from Argentina, Brazil, Mexico, Canada; so essentially for all our key geographies there we enjoyed a strong pricing.

I think it should continue.

LAC last year and this year, they're really performing very strongly.

I think they had a good momentum.

As I mentioned earlier answering other questions, there is a bit of a share pressure in Mexico.

But on the other hand, Mexican total industry volumes are doing better; so overall in the financials, we're looking pretty okay.

On South Korea, it looks that our initial guidance for the total market for the year, 20%, 25%, decline is now lower; total closer to the 20%.

It's still significant, but let's remember -- I'll let you remember how big the price increase was.

So I think overall it's going better or slightly better than expected.

And our share is up.

So I think, yes, I mean we have the tax increase, price increase behind us; let's see how this is going to unfold.

But so far it unfolds pretty strong.

And, on Australia, not much really as I mentioned earlier, which would happen there.

The prices went up.

There continues some sort of discounting.

The down-trading is there maybe to some extent at the lower level.

Australian total market volume is obviously distorted year on year due to the tax price changes.

I think on the year-to-date basis, Australia is 0.7% actually up total market size.

But, this doesn't mean that the market grows; I think it's a little bit of a distortion there.

Okay.

Cool.

Thanks very much.

Adam Spielman, Citi.

Hi.

Thank you very much for giving me some airtime.

Most of my questions have been asked, so it's really a question of following up a couple that have already been asked.

In terms of the question on EMEA pricing, you said that -- and it was certainly below -- the pricing was below my expectations.

And in reply to that, you said, well, there must be some mix factor.

But obviously you get pricing per se excluding mix.

And I was just wondering if for any geographies -- and you've had good pricing in Russia we know.

So are there any geographies where pricing perhaps has gone backwards or has been disappointing within EMEA?

Not really.

I mean just one thing to clarify always when we talk about the pricing is the pricing variance.

When we report the volume/mix, we report the mix with the volume (multiple speakers)

Yes, indeed.

Okay.

But yes, there was some negative mix for EEMA, and I think largely driven by Russia.

On the other hand very encouraging -- and I haven't seen these results for the long time: we've had zero mix impact in EU.

Okay?

So that on the total PMI basis, the mix is not that much of a major issue.

Obviously, you have the mix in Australia due to the down-trading, but in a few isolated geographies.

Okay, so that's very clear.

Just coming onto EU, obviously the volume decline has returned to its historical -- or nearly to its historic -- average.

I was just wondering if you think elasticity is about where it was before, or whether we have some way to go before we return to where it used to be?

Well, I think many markets have returned to what we would call the standard sort of tobacco product elasticities: minus 0.3%, minus 0.5%; and I see more and more markets which are squarely fitting into this range, even maybe some of them in the lower end of this range.

So in a minus 0.3% territory.

So that's good.

Just one final question, following up a question that Bonnie asked.

Clearly your marketshare is improving and a lot of that is to do with 2.0.

But there's also the new commercial approach, and I was wondering, really two questions related to that.

Is it possible to say at all which is more important, the new brand architecture or the new commercial approach?

There's obviously a bit of both, but are they equally important?

And the second question related to that is, are there any important geographies where you haven't rolled out the new commercial approach yet?

I will start with the second one, important geographies in which we're in the middle of the rollout of the commercial approach is Indonesia, from the large OCI market.

Coming to how much one could attribute to the commercial approach and how much to 2.0, I would put like this.

Marlboro 2.0 is the concept, right?

It's a great concept; it's a great design; it's a great product lineup; it's a great support materials.

And at the end of the day you need to have a damn skilled organization to properly implement this in a market.

So that's your commercial approach.

So this comes both together.

I mean if a great idea, lousy implementations, no result.

If you have a lousy idea, great salesforce, who cares?

No impact.

So I think you need to have always the optimum, the right mix of both.

And I guess we're at this stage now.

Excellent, okay.

Just apart from Indonesia, are there any other markets you'd point to that perhaps don't currently have big OCI contributions but perhaps you could hope to gain share in, that you haven't rolled this out?

This will be my final question.

From the -- no.

There are markets which are -- no, from a significant market I guess it would be Indonesia, which pops up to my mind now.

I mean in many other markets, we're well advanced.

Maybe there are some territories in some places, but we also don't necessarily aim at covering 100% of any given market territory.

It has to have the economic sense.

I mean we're running the details, cost-benefit analysis.

And, no, I think Indonesia would still stay on the list.

I would think about Indonesia.

Thank you very much.

That was our final question.

I'd now like to turn the floor back over to management for any additional or closing remarks.

That concludes our call today.

Thank you for joining us.

If you have any follow-up questions, please contact the Investor Relations team.

We are currently in Switzerland today.

Thank you again and have a wonderful day.

Thank you.

This concludes today's conference call.

You may now disconnect.