菲利普莫里斯國際 (PM) 2016 Q2 法說會逐字稿

Good day and welcome to the Philip Morris International second-quarter 2016 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 2016 second-quarter results.

You may access the release on our website at www.PMI.com or the PMI Investor Relations app.

During our call today, we will be talking about results for the second quarter of 2016 and comparing them to the same period in 2015, unless otherwise stated.

Please note that in this presentation net revenues exclude excise taxes.

A glossary of terms, adjustments, and other calculations, as well as reconciliations to the most directly comparable 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 cigarettes.

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

Now my pleasure to introduce Jacek Olczak, our Chief Financial Officer.

Jacek?

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

As announced this morning, we are raising our 2016 reported diluted earnings per share guidance by $0.05 to a range of $4.45 to $4.55 at prevailing exchange rates.

The revision is driven solely by currency.

Our full-year business outlook remains strong.

Our guidance therefore now includes $0.40 of unfavorable currency and continues to represent a growth rate, excluding currency, of approximately 10% to 12% compared to our adjusted diluted EPS of $4.42 in 2015.

We expect our currency-neutral adjusted diluted EPS growth in the third quarter to be broadly in line with that of the second quarter.

Consequently, our full-year 2016 adjusted diluted EPS growth, on the same basis, is expected to be heavily skewed toward the final quarter, largely reflecting a favorable comparison versus the fourth quarter of 2015, during which we made significant investments behind iQOS and our cigarette brand portfolio.

As seen on this slide, the $0.05 moderation in the currency impact on our guidance primarily reflects the appreciation of the Japanese yen and the Russian ruble against the US dollar since we last provided guidance in April.

Let me now take you through our second-quarter results.

Our organic cigarette shipment volume declined by 4.8%, or by 4.3% excluding estimated inventory movements, due in large part to decreases in low-margin volumes in Pakistan and the Philippines.

These markets accounted for approximately 2 points of the organic cigarette shipment volume decline.

Net revenues and adjusted OCI in the second quarter increased by 1.4% and 1.8%, respectively, excluding currency.

The growth in adjusted OCI reflected favorable pricing, partly offset by negative volume mix particularly in the EEMA and Asia regions, as well as higher costs related to the commercialization of iQOS.

Adjusted diluted EPS increased by 1.7%, excluding currency.

Our favorable pricing variance of $344 million in the second quarter reflected positive contributions from all regions, notably EU and EEMA.

The favorable pricing in the Asia Region was driven by Indonesia and the Philippines, partly offset by Japan and Korea.

During the quarter, we announced or implemented price increases in a number of markets, including those shown on this slide, which should support favorable pricing in the second half of the year.

In addition, earlier this month we received approval from the Ministry of Finance in Japan to increase the retail price of select Parliament variants by JPY10 per pack, effective August 1. For the full year, we continue to anticipate a pricing variance of around 6% of our 2015 net revenue.

Our cigarette market share, excluding China and the US, declined by 0.4 points in the quarter, due mainly to the Asia Region.

Marlboro cigarettes share increased slightly, with growth in the EU, Asia, and Latin America & Canada Regions, partly offset by a decline in the EEMA Region.

Turning now to our Regional results, cigarette industry volume in the EU Region declined by a modest 0.3%, excluding estimated inventory movements, reflecting a continuation of the four favorable trends listed on this slide that we have observed over recent quarters.

We also attribute some of the industry resilience to the estimated favorable impact of immigration in select geographies.

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

It concluded that the incidence of illicit trade in the EU declined by 0.6 points to 9.8% in 2015, with decreases in most major markets.

For the full year, we forecast a decline in cigarette industry volume of around 1%.

Our cigarette market share in the EU Region decreased by 0.2 points in the second quarter.

The decline was due mainly to Germany and Italy, partly offset by share growth in four of the Region's other largest markets by industry volume, where Marlboros share increased.

In Germany, the share decline was due in large part to estimated inventory movements, though it also partially reflected the impact of L&M leaving its round EUR5 price point in 2015.

In Italy, the decline was due largely to the timing of competitors' price increases as well as adult smoker down-trading to the mid and super-low price segments.

Regional adjusted OCI increased by 3.5%, excluding currency, driven by higher pricing, notably in Germany and Italy, and supported by the resilient cigarette industry volume performance.

For the full year, we are targeting currency-neutral adjusted OCI growth in the high single digit range, driven in part by a favorable comparison in the fourth quarter.

In the EEMA Region, we recorded strong results in the quarter with adjusted OCI growth of 10.1%, excluding currency, driven by Russia, Saudi Arabia, and Turkey.

In Russia, higher pricing drove another quarter of double-digit currency-neutral OCI growth, consistent with our full-year target.

Cigarette industry volume declined by 6.8% in the quarter and by 5.3% June year-to-date.

Our cigarette market share decline in the quarter was due mainly to the slower penetration of our competitors' price increases.

Given the continued resilience of cigarette industry volume, we now forecast a full-year 2016 industry decline of around 7%.

Turkey also recorded solid currency-neutral OCI growth in the quarter driven by favorable volume/mix reflecting higher cigarette shipment volume supported by Marlboro and higher pricing.

Our strong currency-neutral adjusted OCI growth in the EEMA region came despite negative volume/mix in North Africa, where general macroeconomic and geopolitical instability continued to put pressure on cigarette industry volume and premium-priced products, including Marlboro.

In Algeria specifically, Marlboro has also been impacted by the combination of steep excise tax-driven price increases earlier this year and lower-than-anticipated adult smoker acceptance of the 2.0 Architecture for Marlboro Round Taste.

In the Latin America & Canada Region, we recorded cigarette share growth of 0.7 points driven by Brazil and Canada.

Marlboro cigarette share increased by 0.4 points, reflecting growth notably in Brazil.

Currency-neutral adjusted OCI declined in the quarter due largely to lower cigarette industry volume in Argentina following a significant excise tax increase in May, which resulted in retail price increases of approximately 50% on an industry weighted-average basis.

The decline was partly offset by favorable pricing, notably in Argentina and Canada.

Turning now to the Asia Region, our adjusted OCI declined by 5.4%, excluding currency.

This was due mainly to unfavorable volume/mix and higher costs related to the commercialization of iQOS.

The lower volume/mix was predominantly in Japan, primarily reflecting an unfavorable comparison with the second quarter of 2015 related to distributor inventory movements.

For the full year, we are targeting Regional adjusted OCI growth, excluding currency, in the mid to high single digit range, driven in part by a favorable comparison in the fourth quarter.

Our positive full-year outlook for the Asia Region is supported by favorable developments in several of our key markets.

In the Philippines, price gaps between Marlboro and lower-priced brands remained stable throughout the quarter and represented a significant narrowing compared to the second quarter of 2015.

This continued to support our share growth and positive mix.

In Indonesia, our quarterly market share is beginning to stabilize on a sequential basis and has benefited from our latest launches and geographical expansions in the machine-made kretek segment.

For the full year, we are targeting double-digit currency-neutral OCI growth, despite a cigarette industry volume decline forecast in the range of 1% to 2%.

In Japan, we are also seeing signs of stabilization in our cigarette market share on a sequential basis, after excluding the estimated impact of inventory movements.

Marlboro is responding well to the reduced price gap with the leading brand in the market, while recent launches -- such as Lark 7.0 Splash Purple in the differentiated menthol taste category -- are showing positive momentum.

I will now cover iQOS, beginning with our exceptional performance in Japan.

HeatSticks market share has increased steadily since the national rollout in mid-April, reaching an estimated 2.7% for the last week of June.

For the second quarter, HeatSticks market share reached 2.2%, more than double its first-quarter share.

Given the success of iQOS, we are working to effectively manage our HeatSticks capacity and iQOS device supply to ensure we can meet HeatSticks demand over the balance of 2016.

The performance of iQOS in Japan has been supported by growing adult smoker conversion.

Based on our most recent data, 70% of iQOS purchasers have either fully or predominantly converted to it.

Our research in Japan also indicates two other positive developments.

First, the level of HeatSticks cannibalization from our own cigarette portfolio has declined to around 35% from around 40% when we began the initial geographic expansion of iQOS last September.

Second, the growth of HeatSticks is resulting in up-trading as adult smokers across all price segments are converting to a premium-priced product.

The strong performance of iQOS in Japan highlights its potential in our other launch markets, which today are in earlier stages of commercialization and geographic coverage.

Importantly, we are seeing encouraging HeatSticks offtake volume trends in all launch markets.

Chart highlights our weekly indexed offtake volume performance during the first half of 2016 for the launch geographies where iQOS has been present since the beginning of the year.

The commercialization of iQOS continues to progress well across other metrics.

As highlighted by Italy and Switzerland, we are generally achieving combined full and predominant conversion levels in line with those in Japan.

We are also seen decreasing cannibalization rates in both Italy and Switzerland, consistent with Japan.

In addition, iQOS was present in 10 markets by the end of June, following its commercialization and select cities in Denmark, Germany, and Monaco.

We remain on track to launch iQOS in key cities in around 20 markets by the end of this year.

In conclusion, our second-quarter results were generally in line with our expectations, reflecting favorable developments across many of our key markets, though cigarette shipment volume was lower than anticipated due to Argentina, North Africa, and Pakistan.

We are making exciting progress with the commercialization of iQOS and are on track with our launch plans for this year.

We remain focused on generating strong free cash flow and continue to forecast full-year 2016 free cash flow broadly in line with last year's level.

The outlook for 2016 remains strong.

We are raising our 2016 reported diluted EPS guidance, which on a currency-neutral basis continues to reflect a growth rate of approximately 10% to 12% versus 2015 adjusted diluted EPS of $4.42.

Thank you.

And I will be now happy to answer your questions.

(Operator Instructions) Matthew Grainger, Morgan Stanley.

Hi.

Good morning, everyone.

Thanks for the question.

Jacek, I just wanted to ask two questions about guidance, I guess.

One, just from a volume perspective.

In the past, you've talked about an expectation for volume declines down 1% to 1.5% and the industry down 2% to 2.5%.

Obviously you're down about 3% in the first half.

So just, have your full-year expectations changed?

And when we look at the impact of a few large excise tax increases like Argentina and Algeria, has the excise environment in any way shifted or become more challenging?

As far as on the volume, look, I think at this stage I think it will be fair to say that we will likely, very likely, miss our volume expectations -- initial expectations for the year.

I think we will come definitely lower than 1.5% decline, which -- a 1% to 1.5% decline.

We might be as low as 3% for the full year.

This will be coming from the few geographies which not necessary put a big pressure on our bottom-line.

But at this stage that might be the outlook for the full year.

This obviously may result in some industry volumes to be adjusted accordingly.

I think initially we said that the industry somewhere should be in the range of a 2% to 2.5%.

I think the industry might be lower by 2.5%.

But we will have to see, okay?

Just to be on the cautious side.

Now when it comes to tax increases, yes, Argentina was a very large increase and resulted in a very high price increase.

So there is, I think, at this moment -- we can see the impact on the volume and I think it may continue for some time, maybe not for the long time, because this outsized tax increase happens in the high inflationary market.

I guess the time will be a -- will help the consumers to accommodate to the price level I would argue faster than in average situation.

And outside Argentina, frankly speaking, we have not had anything which would be very disturbing on excise increase.

In Algeria it's much more the whole context of the North Africa, the political instability, what is happening at the borders in the individual markets, countries there.

Plus we have a specific to us issue which I highlighted in my remarks connected with the rollout of Architecture 2.0 for the Marlboro Red variant, when we had -- I have to admit -- the first market in which we've been confronted with the less or lower-than-expected acceptance of a new Marlboro.

As you know, we have rolled out the new Marlboro to 100-plus markets, and this is the only market in which we had some significant headwinds from the beginning of the year.

We're obviously working on addressing that thing.

It's a marketing perception problem.

But it may take us some time to address it.

So hopefully part of that improvement we should see already this year.

I hope I answered your questions.

Sure.

Yes, thanks, Jacek, and I guess thanks for clarifying on the volumes.

As far as the EPS guidance, you reiterated 10% to 12%; but it seems like it's going to be around 2% through the first nine months.

So that, just based on our rough numbers, suggests about 50% growth in Q4 and basically would imply maybe that the margins are similar throughout the year rather than stepping down in Q4.

So I guess mechanically I can see how it works.

But the comparison to last year's elevated spending in fourth quarter seemed to be about a 3% to 4% tailwind for the full year.

So in terms of closing the gap and getting up to that 10% to 12% range, are there any other specific factors or sources of flexibility around the timing of reinvestment that you can point to, just to increase our confidence around the levers you have to pull to get up to that level of earnings growth?

Look, for the full year we said that our total cost -- conventional combustible cigarettes and RRPs -- will not be higher than 1%, excluding currency, full-year 2016 versus full-year 2015.

Now, part of this cost and the timing of the cost increases year-on-year are more in the beginning of the year rather than the second half of the year.

So when we enter into Q3, but Q4 very much, we really will have very favorable comparisons not only on the cost line, also on the revenue.

I just want to remind that -- you may remember the number presumably very well -- we're at the EPS minus almost 4% in Q4 last year.

So -- and that clearly will come very strong -- with a very strong growth this year.

And it just happens that this is a phasing and a timing of the quarters, partially the comps, especially the events of the current year, how we're going to make it.

Look, we're very confident of achieving 10% to 12%, but do understand that the pacing of the quarters is not maybe ideal.

But the year has four quarters, and we're working on delivering the 10% to 12% EPS growth ex-currency.

Okay.

Thanks again, Jacek.

Bonnie Herzog, Wells Fargo.

Hi, Jacek.

I wanted to circle back with a quick question on the volume deceleration you mentioned in the year.

You are now expecting shipment volume to be worse than you originally anticipated, so I guess I'm curious to hear from you: What is offsetting the weaker volume to give you the confidence to maintain your currency-neutral EPS guidance of 10% to 12%?

And should we assume growth will be closer to the lower end of that range, given the weaker volume?

Look, it's a good question.

Thank you, because actually it reminded me that I forgot to put it in a context of iQOS.

Okay?

That the volumes which we did the guidance or did the expectations for the volume which we share are obviously on the combustibles cigarettes.

And as you noticed, presumably, on the quarter already we started selling quite significant volumes of iQOS, which are not included in this number.

Now, clearly iQOS sales or HeatSticks sales for the year will to some extent offset the volume declines which we have on our combustible business.

That's on a positive side; will not fully offset because we have capacity limitations on the HeatSticks which I may cover in a second.

Having said so, some of the volumes which we -- may come short this year, they are coming from the relatively lower-margin places.

Except for Algeria where we have a problem with Marlboro, I mean, the Pakistan volumes, the Philippines volumes, they count in the statistics, if you like, but do not really make a big impact or big change at the bottom line.

So we're pretty comfortable, especially Philippines because the market is losing and we're losing the extremely low-margin volumes or zero-margin volumes at the bottom of the market.

And we're having some positive recovery for the mix for Marlboro.

Now, coming to iQOS is that, as you might have noticed, the shipments for the total PMI of iQOS in the quarter to 1.6 billion.

They are almost 4 times higher than what we had in the first quarter.

So we can see the dynamics of the acceptance of iQOS.

Obviously, it's very much driven by Japan, and we have to be very much focused on Japan this year because we don't have an unlimited capacity.

You might remember, we have accelerated the launch plans of all markets, including Japan, by about a year, not being fully ready on the manufacturing side.

Initially, our capacity was to be in the range of 5 billion units; we have made some efforts to increase that capacity by 1 billion or so this year, but I wouldn't expect any further miracles on the capacity this year.

And we may continue with some pressure on the capacity through the beginning of this year.

We're right now revising our CapEx plans and we -- in order to accelerate not only the increase or the acceleration of the [30] billion capacity plant which we're building in Italy in order to be able to satisfy the market demand.

Okay, that's helpful.

I actually did want to ask you also about what you're seeing in Japan with iQOS.

You called out in the press release your combustible cig share in Japan was 25.8%; and then for iQOS -- your HeatSticks, I should say, 2.2%.

And you noted that your combined national share in Japan is 27.5%, which is a nice share gain of over 2 share points versus the year-ago period.

So I was hoping you could talk about the rate of cannibalization from iQOS that you're seeing.

It seems maybe low.

And are you seeing lower cannibalization in Japan, for instance, versus other markets?

I'd just love to hear the differences in cannibalization rates by market.

We did -- we do in this year better cannibalizations, i.e., lower cannibalizations rate in Japan now as we had six or so months ago.

So I had the numbers; I mentioned the numbers in my remarks.

That's a pretty nice improvement.

And we see the same in other places, in other markets outside Japan, although, obviously we're in a much more focused, smaller territories, etc.

Now Japan's share, which we have disclosed today, allowed us to lift the total Corporate share, i.e., for both combined categories, by more than 2 points.

I think that's significant, especially on the Japanese.

Now, what's more important is if we look at the exit shares of June.

So if I take the last week, last two weeks, how we've been cruising in Japan, we have crossed the 5 points, 5% share of market mark in Tokyo, okay?

And we're still growing.

The volume growth is somewhere in the range of about 20%-plus on a monthly basis.

So we could see the push.

We could see the consumers coming to iQOS stores and to other places in which devices are available almost fully prepared, fully one could say converted already to the use of iQOS, since the conversion rates are double of what we had at the beginning of our iQOS journey in Japan.

We estimate, Bonnie, that at this point in time, we must have above 600,000 exclusive or fully switched users of iQOS in Japan.

Essentially, translate to 600,000 people in Japan quit combustible smoking and they fully adopted iQOS.

I think it's spectacular.

No, that's great to hear.

Thanks for the color there.

And just one final question, if I may, on your margins.

Your operating margins were down 200 bps in the quarter.

So I guess I'm trying to understand what some of the key drivers of the margin contraction were.

Also curious to understand why margins were down this much considering your volume declines that you mentioned in the quarter were really mainly in the low-margin geographies.

I guess I would have assumed you would have had a little bit more of a positive mix there.

I think the inventory comps which we had and the shipment-driven comps which we had in Japan were very much behind the PMI and Asia margins.

You're talking about 1.9 billion difference in shipments in Japan on the conventional cigarettes, on the combustible cigarettes.

This would clearly give you the impact just from that in the north of $70 million.

So I think that is what we've been missing.

We have -- the way we look on this thing also is: Are we lifting the margins Q2 to Q1?

Because we ended up Q1 with not so great margins, and I think sequentially we're going up, and I think will have more of the margin improvement for the year when the pricing realization is getting usually stronger in a number of places.

We have a much better situation with the pricing in Ukraine which, relative to a lot of other margins in Q1, a bit less or much less in Q2; and I think that things are going in the right direction.

And, as I said, some of the volume headwinds which we have going forward, except for Algeria, they are not really coming from high-unit margin countries.

All right.

Thank you.

Judy Hong, Goldman Sachs.

Thank you.

Good morning.

I wanted to ask about pricing.

In 2Q, your pricing variance of $344 million is still tracking a bit below the full-year run rate.

I know you called out a couple of factors, but maybe if you can just quantify the key drivers.

And then it sounds like you're still expecting a 6% pricing variance for the full year, which implies a big acceleration in the back half.

So just wanted to get your comfort level around that.

And then related to that, you also called out some increased promotional support on iQOS, it sounds like in Japan, that hurt pricing.

So maybe you can give us some more color on that as well.

Okay.

I think the first half of the year, Q1, a bit of Q2, is still impacted by Korea, right?

So the price realization optically looks at the lower level due to the comps; plus we had quite significant price reductions in Ukraine at the beginning of the year, which I just mentioned a moment ago.

These are fading out and the situation is improving.

So, Korea impact in the outer quarters is no longer there, negative drag is no longer there.

Ukraine should get better.

Plus we have a pricing which was taken in the quarter, so I think we will have more of the realizations.

Indonesia always plays the significant role because beginning of the year they're not really in the net price, to the increases, and now they are moving into the positive price territories.

So I think the 6% is achievable and I think we feel confident about this.

There is a pricing -- some price negativity due to the allowances of discounts which we are giving to the iQOS purchasers -- not the HeatSticks, but iQOS purchasers in Japan.

And although over a period of time we will have reduced in the end per-device the discount, due to the higher volume of the devices which we're selling, that puts a little bit of a negative on the pricing variance due to the allowances behind iQOS.

But on the other hand, you always presell devices first, and then the HeatSticks with the adoptions rate are following very soon.

And the HeatSticks actually are bringing the whole margin to the business.

I think that's on a positive side.

Okay.

That's helpful.

Then I was hoping to get a little bit more color on Russia.

I think your industry volume forecast is now a little bit better, down 7% for the full year.

But it seems like your market share trends have worsened, particularly in the low- to mid-priced brands.

So when you compare the situation this year versus last year, where you were actually gaining share, what changed in terms of the market share performance?

Is it your decision to not be as aggressive in the low- to mid-priced brands from a pricing perspective?

Has the competitive landscape gotten worse?

So just color on Russia.

No, I think from the beginning of the year we observed a bit of lower or slower price implementation from competition.

So, yes, I think I have said already in Q1 that we might feel some share pressure in Russia.

We just stick to our plan.

We target double-digit OCI growth, and I think we can deliver on that.

Part of this share pressure is literally the timing of the price implementation.

So I don't think there is anything fundamentally broken with the brand; it's just the temporary opening of the price cuts in the market.

So I wouldn't be too much worried about this.

On a positive side, you remember initially we thought that the market with this pricing in mind should take about a 9% or so decline.

Seems that the elasticity continues to be on the more positive side for us.

I think 7% is the recent outlook for the industry volume, so I think we should okay.

Also important is that we see a guidance -- the guidance improvement on ruble exchange rate, so I think that the whole pressure on the Russian economy is a little bit less.

It's improving a bit than initially we talked.

Okay.

So just if I can clarify, the pricing, the timing of the price increases and the competitive actions -- are at this point all of your competitors now in line with your pricing?

They're all in line with the pricing.

But if I would be, for example, 80% of price implementations, coverage of the product with the new price in every retail outlet in Russia, competitions might be at the 60% or 50%.

They're just rolling out the prices.

The price increase does not, Judy, happen at one day in all outlets, okay?

You're shipping the old product, new product, more of the new product, a new priced product.

This is a typical price implementation in Russia -- and actually in many other places as well.

So we just see that they're buying -- the prices which they are implementing in the market are in line with, if you like, our pricing.

It's just they have less of a distribution, if you like, of their product at the new prices than us in a given moment of time.

So, obviously, in these outlets when the price gaps is opening, at least temporary, some of our brands might feel pressure.

Okay; that's clear.

Then my just last question, just quickly on currency.

On the yen, obviously it's been a big favorable move in the last few months.

So wanted to just get an update on your hedged position on the yen, how much you are covered for this year and what the effective hedge rate is for this year.

Well, with the forecasted cash flows, etc., from Japan for this year we have above 70% hedged.

And I think it was the first quarter in a long time when effective rate of the yen this quarter was, by a bit, but better than the effective rate of the yen the same quarter last year.

So we're essentially moving the yen into positive territory.

Got it.

Okay.

Great, thank you.

Vivien Azer, Cowen and Company.

Thanks.

Just wanted to follow up on iQOS; sorry to belabor the point, but certainly your results are very encouraging.

As we think about the outsized demand that you're seeing in Japan, how has that influenced your outlook for spend more broadly in the 20 markets that you are targeting?

Well, we're still aiming the commercializing iQOS in a 20 cities market by the year-end.

Obviously, as I mentioned earlier, we have to bear in mind that we don't have a fully available capacity.

We are today in a situation that we have national coverage -- the only place where we have national coverage is Japan, and we know that those who switch to iQOS, so 600,000-plus customers in Japan, we cannot put them in a situation of out-of-stock.

Because they themself tell us that after two or three weeks of smoking iQOS, they actually don't want to, don't like to, and they cannot switch back to cigarettes.

So we're a little bit trapped now in this situation, that we have to make sure that in Japan has continuity of supply before we start put foot stronger on the pedal in other places.

So we're preparing our iQOS stores.

I think by now we have more than 20 flagship stores in a number of geographies, obviously including Japan.

We're preparing the Internet.

We're preparing the salesforce there, the whole commercializations.

We can start.

We're recruiting the first consumers, the first smokers in these places.

But frankly speaking, at this stage, throwing more resources will just generate a higher demand and we are not in a situation where we can meet that demand with our supply constraints at this moment in time.

So this is how we have to work.

The second market which is close to national expansions, not full expansion, is Switzerland.

In Switzerland we start moving, as you remember, the market share in the German part.

I think we grew the volumes in that part by about 50% quarter-on-quarter.

We continue growing the market share in the French part.

I think we closed about a 2% market share at the end of Q2.

So it's not in our interest now, knowing that we don't have a continuity of supply at this moment, to push too much on iQOS.

That's very helpful.

Thank you.

Just to follow up on that, when you're referring to national distribution, should I understand that to mean that you've got 100% of your targeted retail penetration in a market like Japan, or you're getting close to that in Switzerland?

Or are there more stores that you want to enter?

Japan, I guess, is fully covered now.

There may be a few outlets.

Okay, we have some limitations on the device sales because the only way we can manage the constraints on the HeatStick capacity is to limit the iQOS device sales.

And actually, to be frank, in all outlets in Japan -- key accounts, general trade, etc.

-- they had a purchase limit per store.

And I think we're shipping the product only twice a week, with very limited quantities, in order to stop or slow down the conversion because it will result in a higher demand for the HeatSticks, and the HeatSticks is a bottleneck which we have for now.

And the same applies to a large extent to other places.

Now if I compare Switzerland, I think iQOS is now available in 200-plus outlets.

So we're not really in a full national coverage in any of these places.

Moscow, we're in a couple of stores; we have one store in Lisbon.

So it's really very small.

But if I look at the volume trend, which if you -- you might remember from my presentation a few minutes ago -- the volume trends are extremely encouraging.

You have a truly exponential growth.

That's very helpful.

Thank you very much.

Michael Lavery, CLSA.

Thank you.

Just coming back to currency, I know it's early to look ahead to next year, but in our numbers it looks like you've actually got a slight tailwind which, of course, we haven't really talked about for a long time.

Just very roughly, does that seem accurate?

And I guess related to that, can you just remind us some of your thinking about if and when you would consider resuming buybacks?

Well, Michael, look, I wish I knew what the currency is going to be next year.

But let me put that away.

We had a headwind on the currency for the last three years.

So I think it would be very fair if some of this headwind converts into tailwind to us.

Now once we have a strong tailwind on the currency, I think we might be then only in the situations to reconsider the buyback.

Would it be fair to say that you want to be careful so that you don't resume buybacks just to have to suspend them again?

Is that part of how you think about it?

Well, we'd rather -- I think if we were to arrange for the buyback, we would like to see the positive outlook for the next few years, so have something of the, I guess, more longer-lasting program than just one quarter or one year with the buyback.

Remember our focus always more strategically is on the dividend and creating the room for the dividend growth; and buyback comes after all other opportunities to invest.

Buyback will come last.

No, that's helpful.

Thanks.

Then back on iQOS, can you remind us when full capacity comes online?

I think you've said it was the end of this year.

But how specific can you be?

Then related to that, you have acceleration in it looks like every market, especially Japan, which is the biggest.

If that continues, is it possible you might need to postpone the other 10 markets that you expect to launch in this year, just to be able to keep servicing the ones where you're already present?

Well, the other markets which we have in the plan for this year is, they will -- I think postponing the market would delay the entire commercialization.

We know that as of Q1, Q2, late as next year, based on our sales forecast, obviously, we should be in a comfortable capacity territory.

So I think we'd rather let the market go as we had per plan.

One iQOS store will not put that much of a stretch initially on our capacity, which is very mindful in the development in Japan, because that's -- every few percentage error on the forecast which we have translating to tens of hundreds of millions of HeatSticks, and this is where the focus is for the time being.

Capacity -- the initial plan of the building, the factory, for 30 billion, we're actually accelerating that delivery of that capacity.

And as I said, as of Q1 we should month by month see the progression in available capacity.

But this is obviously confronted with the pretty steep growth curve which we have in Japan.

So we have a little bit of a vicious cycle on this side, but we're right now also working on resolving that problem.

But just to clarify, I think you've got the 5 billion to 6 billion capacity out of Neuchatel.

The plant in Italy, when would that come online?

We already started producing in Italy, okay?

We're producing a little bit in a -- still in a development center in Neuchatel in Switzerland, and this is mainly to keep demand satisfied in Switzerland.

And the Bologna plant, both the training center and the new factory actually started producing the HeatSticks, and they are already shipping everything to Japan and a few other places.

So the start of factory from the structure perspective and infrastructure is ready.

We're just in the phase of installing the machines.

So there is a pace of installing the production line, and every month we will be better with the capacity.

But we cannot just install 30 billion in one go, 30 billion translating to X number of machine groups that one by one have to be installed, tested, and moving to commercial production.

Oh, okay.

That's helpful color.

Then just lastly on Italy, it looks like in your one slide you've shown an acceleration in momentum there from the beginning of the year.

Obviously, that's a market where there had been relatively little traction.

How much has that picked up?

What kind of share are you seeing now?

It seems, I'm guessing, still pretty small; but what have you seen made a difference that it's better than it was?

Because we see the higher conversion than we initially had.

So Italy, like Japan, a month ago started with 30% or so conversion, and I think Italy is approaching 70% conversion.

So from every 100 devices which we sell, iQOS devices which we sell, 70 devices are in a permanent use; i.e, consumer has fully switched to iQOS.

Now share for total Italy is not a fair number, because we're not really present in the whole Italy.

If I take in the places where we are, and assuming that we properly can estimate underlying market in these places -- which you know is a little bit of a science and art actually together -- I think we are approaching about a 0.3%, maybe about the 0.3% in market share.

So versus where we'd been at the beginning, as you remember Milan was for the long time 0.1%, 0.2%; 0.2% to 0.3% is quite a significant improvement.

If I take it from a volume perspective, we see in Italy like in other places about 20% volume growth every month, month on month.

So we're starting with a slow pace, I admit this thing.

But the growth is there.

So I think the moment when we'll be able to amplify Italy to the national coverage like we did in Japan, obviously, we need to discount the different channels of communications which we have available in Italy versus in Japan, but I think that the prospects are there.

I think we should see more and more of a Japan -- of the Italy improvement of non-performance towards the -- in the second part of the year.

And the trend of the volume trend as of Q1/Q2, which you had on the slide in my part of the presentation, is just highlight that we start -- are pushing the right buttons there.

That's helpful.

Thank you very much.

Philip Gorham, Morningstar.

Hi, thanks.

Just a quick one for me.

Clearly the last month or so we've had a number of geopolitical shocks.

I appreciate it's early days.

But have you seen any signs in your categories in any of the affected markets that the consumer is in any way changing their spending behavior?

Thanks, Jacek.

Well, you have some down-trading in some places in North Africa.

Egypt, which as you know the macroeconomic situation is challenging, and Egypt will remain on the watchlist for the remainder of the year.

In Algeria, which on the one hand, is in our marketing of Marlboro, but on the other hand is a bit of a down-trading followed by a few steps of excise price increases.

So yes, the macros are a bit weaker.

Long-term, I guess, the region has a great potential.

If the economy is in the south direction rather than the north direction, then it will put pressure on consumers.

All right, thanks.

That was our final question.

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

Thank you very much.

That concludes our call for today.

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

Have a great day.

Thank you.

Thank you, ladies and gentlemen.

This does conclude today's conference call.

You may now disconnect.