菲利普莫里斯國際 (PM) 2018 Q1 法說會逐字稿

Good day, and welcome to the Philip Morris International First Quarter 2018 Earnings Conference Call.

Today's call is scheduled to last about 1 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 2018 first quarter results.

You may access the release on www.pmi.com or the PMI Investor Relations app.

A glossary of terms, including the definition for reduced-risk products, or RRPs as well as adjustments, other calculations and reconciliations to the most directly comparable U.S. GAAP measures are at the end of today's webcast slides, which are posted on our website.

As a reminder, effective January 1, 2018, we began managing our business in 6 reporting segments, reflecting a new regional structure.

3 years of historical data reflecting the new structure are available on our website and in the Form 8-K that we submitted to the SEC on March 23.

Please also note that we are now using operating income to evaluate business segment performance and allocate resources, replacing operating companies income, or OCI, which was used prior to January 1, 2018.

OCI was defined as operating income, excluding general corporate expenses and the amortization of intangibles, plus equity income or loss in unconsolidated subsidiaries, net.

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

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

It's now my pleasure to introduce Martin King, our Chief Financial Officer.

Martin?

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

As announced this morning, we are increasing our 2018 reported diluted earnings per share guidance at prevailing exchange rates by $0.05 to a range of $5.25 to $5.40.

The change reflects a lower estimated full year effective tax rate of approximately 26%.

Our guidance includes $0.16 of favorable currency at prevailing exchange rates.

Excluding currency, our guidance represents a growth rate of approximately 8% to 11% compared to our adjusted diluted EPS of $4.72 in 2017.

The reduction in our estimated effective tax rate for 2018 to approximately 26% versus the 28% that we had previously communicated is driven by 2 main factors: First, further analysis and interpretation of the Tax Cuts and Jobs Act, primarily related to foreign tax credit limitations due to the global intangible low tax income provisions of the Act; and second, revised foreign income tax estimates due to a change in the mix of our foreign earnings.

I must caveat that this estimate reflects our current capital structure as well as our current interpretation of the new tax law, which may change as further regulations and clarifications become available.

It also reflects current assumptions regarding earnings mix and tax rates by taxing jurisdiction, which may also change.

Our revised guidance also incorporates some caution related to the evolution over the balance of the year of 3 elements, which I will cover in more detail later in my remarks, namely: The timing of price increases in Russia, although the start of the year has been encouraging; slower than initially projected RRP category growth in Japan during the quarter, given the phenomenal category evolution, we are now reaching different socioeconomic strata, with more conservative adult smokers who may have slightly slower patterns of adoption; and the pace of recovery of cigarette industry volume and our market share in the GCC, particularly Saudi Arabia.

Consequently, we have not passed through the full benefit of the lower estimated tax rate to our 2018 guidance at this early stage of the year, but we'll monitor how these dynamics and our related initiatives progress as the year unfolds.

Our revised guidance reflects currency-neutral net revenue growth of around 8%.

Turning to our first quarter results.

We recorded strong currency-neutral net revenue growth of 8.3%, driven by higher volume for heated tobacco units and iQOS devices across iQOS markets, coupled with higher pricing for our combustible tobacco portfolio across all regions, notably South and Southeast Asia and Latin America and Canada.

Adjusted operating income declined by 2.7% excluding currency, mainly due to the following 3 factors, which André outlined previously during our year-end call in February: The impact of the tax-driven cigarette industry volume decline as well as the related down-trading and our corresponding market share decrease in the GCC, principally Saudi Arabia; higher RRP investments, primarily in the EU region; and our full year 2018 contribution of $80 million to the Foundation for a Smoke-Free World, which was expensed entirely in the first quarter.

Adjusted diluted EPS of $1 declined by 1%, excluding $0.03 of favorable currency.

Our reported diluted EPS in the quarter came in $0.13 above the $0.87 forecast that we provided in February.

Underpinned by our strong business performance, this better-than-anticipated result was helped by the lower effective tax rate as well as the timing of certain RRP investments.

Nevertheless, our projection of net incremental investment behind RRPs of approximately $600 million in 2018 remains unchanged.

Combined cigarette and heated tobacco unit shipment volume declined by 2.3% in the first quarter or by 1.1%, excluding estimated inventory movements, primarily in Japan and Saudi Arabia.

The decline was principally due to lower cigarette industry volume, notably in Japan, Russia and Saudi Arabia, partly offset by strong growth in heated tobacco unit volume, particularly in Japan and Korea.

For the full year, we continue to anticipate a combined shipment volume decline of around 2% compared to an industry volume decline of 2% to 3% on the same basis.

Heated tobacco unit volume is growing rapidly across launch geographics.

In Japan, we lifted the iQOS device sales restriction during the first quarter of 2018.

We observed, however, that device sales were slower than our ambitious expectations.

This was due to still limited awareness of iQOS' increased availability and, more importantly, to the fact that we are reaching, earlier in the year than we had anticipated, the more conservative consumers, especially the age 50-plus smoker segment, which represents approximately 40% of the total adult smoker population.

In general, these consumers are likely to display, at least initially, a slower pace in entering the RRP category.

That is, they are less likely to be in the innovators and early adopters groups shown on this chart.

Instead, they are relatively overrepresented in the late majority and laggard groups, which are larger in size.

This is common with any new product category, and especially RRPs and iQOS in particular, given their phenomenal speed of growth in Japan.

We are therefore adjusting our commercial plans in terms of the timing, intensity and content of communication to specifically address the needs of these adult smokers.

In parallel, we are strengthening our loyalty programs for existing iQOS users as competition intensifies.

However, this temporary dynamic may affect our full year total heated tobacco unit shipment volume, which we have cautiously reflected in our revised guidance.

iQOS continued to record strong heated tobacco category share growth in Japan in the quarter at an estimated 80%, and it is the undisputed icon RRP brand.

In fact, as the availability of competitive RRP products has increased, there has naturally been experimentation by certain iQOS users, especially innovators and early adopters, with competitive products.

This has also been due to the iQOS device sales restriction.

However, only an estimated 1% of converted iQOS users fully switch to these competitive products.

This is remarkable, particularly given the premium positioning of iQOS, and is a testament to its potential.

Before closing on this topic, I think it is important to highlight the underlying growth in heated tobacco unit demand.

Even if the aforementioned dynamic [persists], we remain on track to double our worldwide in-market sales of heated tobacco units compared to 2017.

Moving to our market share performance.

Total international share, excluding China and the U.S., increased by 0.4 points in the quarter, driven by higher share from our heated tobacco brands, which were up by 1 full share point to 1.5%.

Over half of the 0.6 point share decline for our cigarette portfolio was due to Saudi Arabia, where the decrease in cigarette industry volume and related down-trading put pressure on the shares of both Marlboro and L&M.

I will now discuss a few of our key geographies, beginning with the EU region.

Total industry volume declined by 4.1% in the first quarter or by 3.4%, excluding estimated inventory movements.

The decline was due mainly to the impact of price [increase], including sizable excise tax-driven price increase in France.

For the year, we anticipate a total industry volume decline of approximately 2% to 3%, consistent with the structural decline rate.

Our total regional market share was down by 0.2 points in the quarter, largely reflecting the impact of estimated inventory movements, partly offset by the strong growth of HEETS, which reached a regional share of 0.8%.

As expected, regional adjusted operating income, which declined by 15.8% on a currency-neutral basis, was heavily impacted by incremental RRP investments.

For the year, we anticipate adjusted operating income growth in the low to mid-single digits, excluding currency.

In Russia, total industry volume declined by 8.3% in the quarter, due mainly to the impact of price increases and higher illicit trade.

For the full year, we expect a total industry volume decline of approximately 7%, consistent with 2017.

Quarter-to-date, February cigarette market share declined by 1.1 point, primarily due to our low-price brands.

Despite continued down-trading in the market as well as adult smoker out-switching to iQOS, share for premium Marlboro increased by 0.4 points, while share for above-premium Parliament was down only slightly.

We recorded a favorable pricing variance in the quarter, reflecting the annualization of 2017 price increases as well as additional price increases earlier this year.

While this is a welcome development, the pricing environment remains a watch out, particularly after the scheduled excise tax increase in July.

Turning to Saudi Arabia.

Cigarette industry volume remains under considerable pressure following the June 2017 excise tax-driven price increases.

First quarter industry volume declined by over 40% and was impacted by a further VAT-driven price increase in January.

Our cigarette market share declined by 12.5 points, largely reflecting the impact of significant industry-wide down-trading following the price increases given the premium positioning of our portfolio vis-à-vis competitors.

We anticipate a moderation in the cigarette industry volume decline in the second half of the year, when the June 2017 price increases have been lapped.

As I mentioned earlier, the market nonetheless remains a watch out, along with the broader GCC, due to the differing stages of tax enactment.

In Indonesia, cigarette industry volume declined by 2.3% in the first quarter, largely reflecting the soft consumer spending environment, coupled with above-inflation excise tax-driven price increases.

For the year, we continue to anticipate an industry decline of 1% to 3%.

Cigarette market share increased by 0.2 points in the quarter to 33.2%, driven by the strong performance of Marlboro Filter Black as well as Dji Sam Soe Magnum Mild, a lighter-tasting, machine-made kretek line extension from the Dji Sam Soe brand family, launched in May 2017.

In the Philippines, excise tax-driven price increases drove further profit growth in the quarter.

We also recorded strong market share growth, led by Marlboro and Fortune.

We are particularly pleased by Marlboro's performance following its price increase in December 2017.

We continue to be very encouraged by the outlook for profit growth in this important market.

I will now turn to the performance of iQOS, beginning in Japan.

HeatSticks continued their strong sequential growth trend in the first quarter, reaching a national market share of 15.8%.

This represents growth of 8.7 points and 1.9 points versus the first and fourth quarters of 2017, respectively.

Looking at iQOS' performance in Sendai specifically, HeatSticks' offtake share growth in the first quarter continued to drive an increase in our heated tobacco category share.

It is worth highlighting that the category share growth in the first quarter was driven primarily by iQOS.

The quarterly share progression of HEETS in Korea also continues to stand out, reaching 7.3% in the first quarter.

To put this performance into perspective, HEETS is now a top 5 tobacco brand in Korea less than 1 year after launch, with a quarterly share approaching those of our leading cigarette brands in the market, Marlboro and Parliament.

Outside Japan and Korea, we continue to record strong sequential national share growth in other advanced iQOS launch markets, with first quarter market shares ranging from 1.5% in Italy to 3.5% in Greece.

This performance demonstrates that we are successfully leveraging our learnings across markets to drive improved execution, higher iQOS awareness and strong conversion.

It is important to also remember that these national shares have been achieved despite not having a full national presence in these markets.

We believe that the even higher quarterly offtake shares in focus cities, such as 3% in Rome and 5.9% in Athens, augur well for iQOS in these markets going forward.

As seen on this chart, we are observing similar trends with our focus area offtake shares in iQOS launch markets that remain more targeted within a limited number of key cities.

This gives us further confidence that our investments behind the heated tobacco category are increasingly paying off.

The growth of our RRP portfolio, coupled with the enduring strength of our combustible tobacco brands, is supporting strong anticipated cash generation in 2018.

For the year, we continue to target operating cash flow of over $9 billion.

We plan to use this cash primarily for capital expenditures to support the growth of our business and for dividends at the board's discretion.

We anticipate capital expenditures of approximately $1.7 billion this year, with RRP-related investment expected to account for around 60% of the total.

We remain committed to restoring, over time, our leverage multiples to the ranges associated with our current credit rating.

Importantly, both Moody's and S&P have recently confirmed our rating, with S&P revising its outlook from negative to stable.

In conclusion, our first quarter results came in better than expected, with the delta compared to our February forecast driven mainly by a lower effective tax rate and the timing of certain RRP investments.

Our leading combustible tobacco portfolio continues to support strong pricing while contributing the lion's share of our earnings and cash flow.

In parallel, iQOS is recording strong sequential quarterly share growth across launch markets, demonstrating our ability to effectively invest and apply learnings in a wide range of geographies.

Finally, the full year outlook for our business remains strong.

Our increased 2018 earnings per share guidance reflects a growth rate of approximately 8% to 11%, excluding currency, compared to adjusted diluted earnings per share of $4.72 in 2017.

Thank you.

I'm now happy to answer your questions.

(Operator Instructions) Our first question comes from the line of Judy Hong of Goldman Sachs.

So Martin, I had a few questions, just in terms of how the iQOS trends played out in the quarter.

So first is just in Japan, how much did device sales actually come in lower versus your expectations?

And is this something that developed in the last 2 months?

Because it sounded like at CAGNY, trends were pretty strong.

I think you had January market share number for iQOS that was higher than the quarterly average.

So just curious in terms of the device sales situation and then if this is something that you've observed in the last 2 months.

Yes, Judy, if you recall, when we were talking about the end of the year call, we mentioned that we were expecting to be able to meet the additional HeatSticks units inventory that we had sent to Japan with additional devices from our second supplier that had ramped up production.

And we did ship the additional devices, and we were anticipating a substantial surge because, as you know, we had short the market for quite some time.

And as it turned out, we were closer to having met market demand than we realized.

We're anticipating that we would reach some sort of a plateau later in the year, given that we knew the consumer dynamics that we had -- close to saturating the early adopters and innovators.

It's just coming a bit earlier in the year than what we had foreseen.

And this isn't unusual.

We've looked at trends of other new products and new successful launches in other situations.

And there's almost always periods where you get surging adoption, and then it plateaus a bit as you enter some new consumer dynamics and categories.

And then it tends to resume some growth rates.

And we think we're at one of those points.

Now we're obviously going to adjust our plans.

We have very good initiatives in Japan that we're going to pull forward earlier in the year, and we need to adjust a bit our messaging to these consumers.

And we don't know how long this plateau will last.

It may -- we may be able to resume better growth rates fairly quickly or it may persist a bit throughout the year.

So we thought it was prudent to reserve some of the benefits from the tax to account for this as well as for the Saudi and Russia pricing.

And we're going to see how it goes for the rest of the year.

It's still early days in the year.

We've got a terrific team in Japan that is addressing these issues, backed up by some folks in the region that have experience in Japan.

And the group here in the headquarters that's putting together a great toolbox for us to address these other consumer segments.

So we're actually quite optimistic about Japan.

We had tremendous growth there.

I mean, to reach about 16% share in such a short period of time is absolutely phenomenal.

It was just an issue of whether this torrid pace of growth would continue uninterrupted or whether we would hit some points at which we need to adjust a bit and approach consumers in a little bit different manner.

And that's just coming a little earlier in the year than what we had hoped.

As far as the -- you had mentioned the shares.

For the quarter, we're at 15.8% versus the quarter 4 last year of 13.9%.

I think you mentioned the January share that probably you were looking at from CAGNY, which was given at 16.3%.

We're focusing more on quarterly shares because there's always a bit of noise in those in-market shares.

They're based on an exchange of data from the different companies.

And sometimes, there's some inventory impacts as they ship to retail.

If you look at December of last year, the in-market shares percent was 14.1%, so that -- it was probably a little understated versus -- due to some inventory increases from our competitors.

And then 16.3% came in, in January probably a little overstated because of the reversing of that effect.

But if you look at, say, quarter end to quarter end, so December was the last month for Q4 at 14.1%.

March of this quarter is at 15.6%.

So we're seeing a good trend in Japan in offtake.

What we're flagging for the rest of the year isn't really -- you don't see it in the first quarter numbers.

What we're really flagging is the growth, the speed of uptake of new consumers as measured by how quickly they buy the devices.

And rather than get a big surge from pent-up demand that we had optimistically estimated, we're seeing still good growth, still good number of new consumers coming to the category.

We just don't have that surge there of devices, and therefore, we can project forward and see that our HeatSticks sales, which come as a lagging indicator to the device sales, are likely to be a little bit lower than what we had flagged at the year-end call.

And therefore, we're being cautious in reserving some ammunition to deal with that.

Okay.

And then if I can just clarify the distortion, though, between the in-market sales number versus the shipment number, because it seems like last year, particularly in the fourth quarter, there was a bigger sort of over-shipment of iQOS versus the in-market share number.

So as you think about the kind of a little bit slower adoption of the more conservative consumers and then you also have this big inventory that's probably still in transit or in somewhere in the channel, how do you think about accounting for that as you think about shipment volume in 2018?

Okay, so let me go back a little bit to what we said previously and remind a little bit what the setup was.

So we started the year last year with almost no inventory because we were behind on HeatSticks.

And only later in the year were we able to start catching up a bit, and we called out in Q3 and also in Q4 that we were actually building what we thought -- what we think still is an appropriate inventory for Japan.

If you recall, we said that for the full year, we built inventories at the company of $8.5 billion net of conventional cigarettes.

So in Japan, obviously, we were providing for an appropriate inventory of heated tobacco units while at the same time reducing our conventional cigarette inventory.

So we had called out the $5 billion that was in the fourth quarter and a total of $8.5 billion throughout the year.

And of course, we were at the same time, we were shifting from air shipments to sea shipments.

We were still relying and still are relying primarily on one factory, so we needed to have some safety stock to deal with any potential disruptions and so forth.

And we were also anticipating HeatSticks to meet the new device volume, which had become the bottleneck by the second half of the year.

So I think we were pretty clear to say that within our numbers for last year was a buildup of the inventory for heated tobacco units in Japan.

Now for this year, we've got that inventory.

We don't expect it to reverse from the point of view that we have excess inventory.

We have an inventory that's appropriate for a rapidly growing product category and appropriate for the long supply chain.

And we've gone to sea shipments and appropriate to guard against any possible disruptions from a supply chain that's still relatively young and relatively focused on a single factory.

But for 2018, you will see pretty stable HeatSticks inventory in Japan.

You will see comparisons year-over-year, which is a variance on variance, where we'll call out the difference in inventory build in 2018 will be obviously lower than the inventory build was in 2017.

So I think you also have to keep in mind that we're back to shipping by sea from Japan.

So you have product on the water that ships and is recorded as revenue when it ships out of Europe primarily, and it takes 6, 8 weeks to get to Japan.

And I think maybe there's been a bit of confusion also with some people reading Japanese government import data within the quarter and mistaking it as having been IMS sales in the quarter, when in fact, it was shipments in the fourth quarter of last year that arrived on the water only in January, February of this year.

So that perhaps is another source of confusion on reading the difference between our in-market sales and our shipments.

Our next question comes from the line of Michael Lavery of Piper Jaffray.

Can you just talk about -- a little bit about what changed in Russia and Saudi Arabia?

Those aren't new issues, but it seems as though they must have gotten worse, if now that's part of what you would point to as your updated -- for your updated revenue outlook.

Okay, sure.

So for Russia, it's more a situation that we still have a lot of the year left to go with the pricing situation.

And we still have the tax increase, which comes only in July this year, which is a pass-on of RUB 5 per pack.

So it's lower than it was last year, but it's coming 6 months later.

So the whole pricing situation in Russia is still unfolding, but the first quarter actually came in pretty good.

We're on track.

There's no big, new news there, but we have a situation in Russia where the timing between when the price is announced and when it actually reaches retail is quite long in Russia.

Because of the way the pricing happens, it has to be declared at production, and then there's inventory and it works its way to the market.

So the time between now and the end of the year, with the tax still to come and the pricing having such a long time to retail, we just called it out as a caution and something that we are still watching and concerned about.

But there's really not big new developments.

You always have the usual skirmishes or lagging from competition and certain SKUs perhaps not coming up in price quite in the way that others are.

That's normal, so it's not really new news.

On Saudi, I think it's a story where we're just now seeing the full impacts of the volume effect of these huge price increases.

We had another price increase in January driven by VAT.

Our market share in Saudi is actually sequentially starting to recover a bit.

In Q3, Q4, we were in the 35%, more or less, market share range.

So while Q1 is way down versus last year, sequentially, it's actually starting to recover.

The watchout is more on the market volume, which is still not in recovery mode.

It's still lower in Q1 than it was in Q4 and Q3.

So again, it's a situation where it's very hard to predict the rate of recovery of the total market volume and our share.

And it's still early in the year, so we're calling it out as a caution.

Again, it's -- we're not seeing numbers that are dramatically different from what we had expected, but it's still very early days, and we want to make sure we have that accounted for rather than just roll it on through to the guidance and then have some news later.

So just help me understand this.

I guess, when you reported your fourth quarter and gave initial guidance, it would have been earlier still in the year, and you're, if I'm hearing you right, nothing's changed.

So is really the updated revenue outlook all driven by iQOS in Japan?

Well, I mean, certainly, iQOS in Japan is probably the piece that's more newer information coming from the way that the device offtake is occurring.

But we're still anticipating a very successful year in Japan, and we're still anticipating double the volume of heated tobacco unit sales worldwide.

I mean, but clearly, if this situation in Japan persists, then our volume estimate for heated tobacco units will be more in the range of 55 billion to 60 billion versus the over 60 billion that we had called out before.

It's hard to say exactly at this point.

We don't know how this trend or the dynamics is going to develop, but we're just calling out kind of a more cautious situation to give us the time and the resources to tackle these different consumer segments in the right way.

So help me understand this iQOS number then.

55 billion to 60 billion is quite different than twice last year's number, which would be more like 70 billion.

I thought you were just saying today that something in the 2x last year was where you thought you might be.

We're having a bad connection.

I really couldn't get that.

Could you repeat that again, Michael?

Yes, sorry.

So if I understood it right, I thought you've just been saying that now you still think you could hit something like a 2x last year's number.

That would be about 70 billion sticks.

But is it more like 55 billion to 60 billion, though?

No, what I'm calling out is we expect to be more than double our in-market sales.

So I'm accounting for this inventory build last year and just -- and comparing our in-market sales last year to what we expect for this year, which would be well over doubling, and giving a more or less cautious range to say 55 billion to 60 billion would probably be a better estimate if this situation persists in Japan.

But overall, we're seeing tremendous growth, not only in Japan, by the way, but if you saw the situation in the other markets, we have a very nice stepped-up share growth and volume coming from a wide range of markets across the EU, and Russia is doing better.

And we're seeing some very good developments and very good news across the world for iQOS and our heated tobacco units.

But obviously, Japan is a big chunk of the volume.

And so when we were revising the numbers, we felt it was best to give a little bit more cautious range.

So can you just help us understand, I know you're learning as you go and this is an evolution in your business that's quite new, but where do you see this going?

And how do you model next year or 2, 3, 4, 5 years out?

You must have some amount of planning around that.

What could an investor expect for what this all gets us and where we're heading?

I'm sorry, Michael, it's very hard to understand you.

I don't know that you have a very good connection or something.

I took away you're asking about how do we model out further years.

Is that what you're asking?

Yes, just so -- if there's some inherent uncertainty around how your business is evolving because this is a new platform and reduced-risk products are a different game...

I'm sorry, I can't hear the question at all.

So I don't know, Michael, you just have a bad connection, maybe you can call in again.

We can go to another caller and come back.

I can't get the question.

Yes, I can try that.

Maybe if you can hear me now, just one more time, what's the outlook like 2, 3, 4 years out?

How do you see your business evolving?

Obviously, there's still some learning you're doing, but what's the endgame for where we're heading?

Well, I mean, we're building a whole new category, not only for iQOS, but we'll be doing the same thing across our entire RRP portfolio.

You've heard our commitment as a company to move as quickly as we can our entire combustible business to reduced-risk products.

We're investing substantially in building the infrastructure not just centrally but in the markets to make this happen.

So we are very committed to this.

We have a strong portfolio of products, not just with iQOS but with other platforms as well.

And as iQOS continues to do well in these other markets, we expect the volume to keep growing extremely quickly as we make this happen.

At the same time, we're not abandoning our conventional product focus.

You see we're getting very good results from our portfolio.

Our pricing in the first quarter is bang on.

We said that for the full year on the conventional side, we would achieve 7% pricing variance as a percent of the combustible prior year net revenues.

And in the first quarter, we're right on track for that, doing extremely well.

The volume is okay.

We're getting some volume back in some markets where we had lost it in Asia.

And overall, we're using the combustible side to fund this transformation to reduced-risk products.

And as far as modeling how fast that will go, it's difficult.

We've said there is uncertainty in this.

We're going to move it as fast as we can, but we're also prudent at the speed at which we invest to make sure we're getting good return for the investments and so forth.

So as far as modeling it out several years, if you've figured it out, have a good model, we'd like to look at it, too.

So as far as the margin outlook, it's hard for you to handicap that right now?

As far as the margin outlook?

Well, okay, look at the situation right now in the first quarter.

You saw a pretty big drop in our margins.

We were down about 4 percentage points.

So let's strip that out a little bit.

About half of that, about 2% of that, is coming from the device impact.

And one of the things you're seeing in the first quarter is that our device sales as a percentage of RRP net revenues was a bit higher than usual.

We had said that we expect around 25% to 30% of the net revenues for RRPs would be coming from devices.

And in fact, in the first quarter, it was about 5 percentage points above that range, around 35%.

And this is partly the impact of what I described before, that we had the devices coming from our new supplier that we ship into Japan, which we record the revenue as we ship it.

And they didn't sell out quite as quickly as we anticipated.

Still, we had very good results, by the way.

It's just not the surge that we anticipated.

So you see a bit of a disproportionate share of the devices in the first quarter versus some of the other quarters.

So that's about 2 percentage points of the 4% volume -- I mean, margin impact.

You've got Saudi in there, which is a huge drag.

Saudi is a very high-margin area, and you're seeing a big drag coming from that.

So that's a big chunk.

And then you have the $80 million annual Foundation, which hit in the first quarter only.

So that's -- those pieces together account for this 4 percentage point.

If you look at some of the regions that aren't impacted by those other pieces, we had very good margin expansion in South and Southeast Asia, in Latin America and Canada.

And then, of course, on top of that, you have the big RRP investments that we put in -- a lot of it is going in the EU, but it's really going really across the world.

There are a lot of other markets as well.

So when you put all these margin pieces together, you see a pretty big impact.

But going forward, we should not see some of these as big a drag as we have seen in the first quarter.

Obviously, on the investments, we'll continue to invest, and part of that is new consumer acquisition and then making the transition.

But there's a certain portion of this step-up in spending which should not just scale the volume.

A lot of it is infrastructure spending, the (inaudible) building a digital approach, which you do it and you build it and it's there, and then it can support a large scale of volume.

It doesn't have to grow with the volume and the transformation.

So going forward, while we'll have more investments, the ratio of the investments to the new consumers should become more manageable.

The other piece is you've got a lag.

You put in your big investments, for example, in the EU, behind gaining consumers.

This is something that we need to do to convert consumers.

We need coaches.

We need the digital approach.

We need a number of investments to make it happen.

And the payback comes fairly quickly, but often not exactly in the same year where you made the investments.

So there's a bit of a lag.

So the step-up that we're seeing this year, we'll see some payback, of course, this year, in the second half of this year, but most of it will come next year.

You won't have -- the Foundation will be in the base next year.

The devices will be there, but we're also working on having the devices be a bit less of a drag.

The cost of them is coming down.

The pricing is a bit better.

And then next year, we shouldn't have Saudi because we will have lapped those results.

And in fact, we have some hopes for the market to recover a bit and get our share back and get some of the volume back as that market normalizes.

So if you put all those things together, logic would tell you that 2019 should be a bit better, certainly on a margin perspective, but also overall business.

Our next question comes from the line of Adam Spielman of Citi.

So I have a really quick question on Japan, but my main focus is the EU.

But to get rid of the Japan one first, you used, in answer to Judy, you use the phrase plateauing.

And you also, if you look at the sequential market share month-by-month, it appears to be falling in the quarter.

Am I getting...

Adam, this is Nick.

We have a very bad connection.

We're going to just switch to a different phone.

So if you can just hold on one second, we'll just make the switch.

Maria, can you switch us -- the operator, can you just switch us to the backup line, please?

Certainly.

Or I could e-mail you the question.

Wait -- we want to hear it from you.

Can you hear me?

Go ahead, Adam.

Thank you.

On Japan, quickly, I think, just to be clear, I think you're saying you still expect growth over the quarters in terms of market share, even though you used the word plateau, which sounds as if it's flat, and sequentially, the monthly market share within Q1 got worse over those 3 quarters.

But I think what you're saying -- am I right to think that you still expect growth in market share over the course of 2018, quarter by quarter?

Yes, we do.

We continue to grow in Japan.

We continue to gain new consumers, and we anticipate that share in Japan will continue to increase.

It's just an issue of the speed of the growth.

And the surge that we were expecting from the finally lifting the cap and having the supply of devices meet the HeatSticks that were already there, didn't materialize as much as we expected.

But we continue to grow in Japan.

We have a very successful product there.

Conversion rates remain intact, and we also are doing very well versus the competition in the heat-not-burn category.

We're growing our segment share.

So it's not an issue of not growing.

It's more of an issue of the speed and the moment at which during the year we knew we would hit a bit of a more difficult-to-convince consumer groups, if you will.

I mean, especially in Japan, you've got a 50-plus age segment that's 40% or more of the total adult smokers.

And iQOS, we're under-indexed in that group.

And that group is over-indexed in more the late adopters and laggards parts of the consumer groups.

And so it takes them a little bit longer to understand and be convinced to try iQOS and to move into the segment.

We're convinced they will.

In fact, many have, because there are quite a few in our -- using our product now.

It's just a matter of timing.

Okay.

Can I turn to the EU?

Two related questions.

Firstly, it sounds like you plan to make some investments in Q1, but you decided not to.

And I'd be very interested to hear about what you didn't do.

And secondly, obviously, market share is progressing.

I think it was 0.6 market share in 4Q, 0.8 in 1Q.

How do you expect that dynamic to continue?

Do you expect it to accelerate during the course of the year?

Or do you think that run rate will continue each quarter?

I mean, when it comes to investments, I mean, whenever you put plans together to have a big step-up in investment, it's always built on project time lines and when you can execute things and so forth.

It's not so much the case of deciding not to move forward.

It's more the case of our ability to pull off this big surge in investments and to get the resources lined up and get it executed.

I mean, obviously, we're making choices on putting more money or less money into individual markets, depending on how the return on investments is coming.

And obviously, there are times when we try something and it doesn't work, and we shift the resources over to another project that is working.

But I'm not going to get into specifically calling out which things are working and which ones aren't working, because I certainly don't want the competition to gain that information.

As far as the speed of growth in EU, I mean, it's hard to predict.

We're seeing better results.

We're very pleased with the way things are moving and the increased rate of growth.

I mean, you called out -- I mean, Italy, where we've been for quite a while, was moving along at 0.1 at best, month-to-month, quarter-to-quarter, and now we're accelerating a bit.

And there are a number of other markets where the results are pretty fantastic.

Greece is another.

So it's very difficult, though, to sit here and give you a rate of progression across the EU.

I mean, we're going to continue to invest overall this year.

We're still on track to achieve our $600 million step-up, which is net of conventional product reallocation.

So it's a considerable sum.

We're trying very hard to spend it wisely.

We've put in place controls and tracking to make sure that the money is getting results before we release more of it and that we reduce programs that aren't working.

And the money and investments, not only in EU, but in other places as well, Russia is a fantastic example, it's really starting to pay off.

And the learnings are coming, and we are getting better at executing the quality of the coaches that we put in place, the number of markets is much better.

The messages are being fine-tuned by market to fit the differences of consumers.

So we're really pleased with where it's going.

We're very optimistic about iQOS growth across the world, by the way, not just EU, but in many other places as well, we're seeing terrific results in quite a few markets.

So the plan is working, and the move towards reduced-risk products is working.

We're very mindful, though, of keeping an eye also on the conventional pieces and not abandoning that part of the business.

It has to be the engine to provide the resources for the gains that we're going to get on RRP.

But you see it worldwide.

Our share in RRP was up 1 full share point year-over-year.

I mean, if you looked at that and said this was like a new brand rolling out across the world, everybody would be jumping up and down with tremendous joy.

And it is, it's pretty fantastic.

And so we're very optimistic about it.

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

I missed a little bit of the call, but I did want to talk to you about your HeatSticks sales outside of Japan, which did increase sequentially but maybe not as much as I would have expected.

So I want to hear from you guys if that has met your expectations and how you expect that to ramp as the year progresses, especially with what you just discussed in terms of the stepped-up spending, conversations you're having with consumers, refining your approach.

Are you more optimistic that, that could accelerate further as the year progresses?

Well, Bonnie, I'm very glad you have very high expectations, and the reality is we do, too.

And I -- did the first quarter HeatSticks sales outside of Japan meet our expectations?

Yes, they did.

We're on track.

We do hope to continue to accelerate the growth, and that's what the investment is for.

Obviously, we've got a fair amount more to spend and more to put behind the growth rate, and we're getting better at it.

We're getting more tuned into what works.

We're sharing very good learnings across markets.

The new operating structure with the COO, Jacek, focused on execution, while the development side works more on the future and the toolbox and so forth, is working very well.

We're still getting this in place, but we're already seeing some benefits from that in improved execution as well as improved speed at which we're developing the pipeline of new tools and new products to come.

We have a terrific plan for the rest of this year into next year for new products, new initiatives, which I can't go into great detail on, as you can imagine.

But yes, I think we're pleased with the results so far, and we're very optimistic that we can accelerate the results going forward.

Okay.

And then just another question on your top line guidance, which changed a little bit, as you guys discussed in a few questions.

So I wanted to make sure I understand the pricing on HeatSticks.

Is that something you guys are adjusting downward, for instance, in any markets as you try to push further conversion?

Just kind of wanted to better understand how you're going to continue to position HeatSticks relative to combustible cigs in many of these markets.

Yes, we haven't changed our plans on pricing for HeatSticks at all.

Our main focus, of course, with iQOS and HeatSticks is consumer acquisition.

So at this point, we're not pushing to try to get a lot of pricing out of HeatSticks.

Obviously, we want to maintain its premium positioning, so it doesn't mean we won't ever change prices anywhere.

But pricing isn't really the name of the game at this point with iQOS or with HeatSticks.

We've got, obviously, increased competition in a number of markets.

So the pricing of the devices and the consumables, we have to keep an eye on competition.

We're priced well above the competition virtually everywhere, which is fine, by the way, because we have a better product, and consumers see it that way.

On the other hand, we have to be careful that they -- we don't get undercut too much.

So we have not changed the pricing on HeatSticks at all.

The slight change in the language on revenue growth, first of all, I mean, we're still saying about 8%, which is pretty fantastic for any company, but especially for a consumer products company.

So I think this is a pretty terrific number to have out there.

We changed it a little bit based on what I already said, which is the potential, if it persists, from Japan for the HeatStick or heated tobacco unit volume to be a little lower than what we had flagged in the previous year.

So we're giving ourselves a little bit of room and range around the 8% and trying to be as forthcoming with everybody as possible so that we don't disappoint on that number.

But it's a very, very solid number, 8% is nothing, I think, to be ashamed of.

No, not at all.

And then just maybe a quick final question for me.

I want to circle back to something you just mentioned about new innovation that you expect to be in the market this year, which you can't talk about.

But I wanted to then clarify, is that baked into your guidance for the HeatSticks volume as well as are you also considering any volume you might be selling in the U.S. market?

Is that factored into your guidance?

Well, look, I hesitate to go line by line and say what's in guidance or not in guidance, because as you well know, a guidance is kind of an all-in number with a lot of puts and takes.

I will say that the U.S. volume is really immaterial for this year.

There's -- first of all, we don't know exactly when it would ship, and we don't have any volume in there for U.S. However, when it comes to other programs, other initiatives, I mean, obviously, when we have a plan and we know it's going to happen, it's part of our overall assessment of what the business can provide for the year.

So for new initiatives and new type -- activities of any type, we obviously consider them when we're putting together our estimates.

Our next question comes from the line of Vivien Azer of Cowen.

So on the top line again.

Sorry to belabor the issue, but that's clearly the concern today.

When we think about your full year outlook for 8%, and I look at the cadence of revenue growth in 2017, it's hard to imagine if you only did an 8.3% in the first quarter and your comps get considerably harder, like what is going to change over the course of the year and allow you to kind of maintain that level of growth when your comps get significantly harder?

So help us understand kind of the cadence of revenue growth, please, over the course of the rest of '18.

Yes, well, I think Q2 and Q3, we're expecting some pretty strong revenue growth, above 8%.

As you pointed out, the real comp hurdle comes with the fourth quarter, where we had a fantastic revenue growth last year in the fourth quarter.

It was 18.8%, I believe, if I recall.

So that comparison does make it more difficult.

And that's -- with that in mind, that's partly why we're putting out there more around 8% versus saying the over 8% before.

But we expect very solid, very strong revenue growth in Q2, Q3 and continued growth sequentially for Q4.

But it's just the year-over-year comparison becomes quite challenging.

I think that's about as much color as I can give you on that one.

Geographically, can you call anything out, like -- that supports that level of confidence around much more robust growth in the next 2 quarters?

Well, I mean, I mentioned that in the first quarter, we had good pricing and that we're on our plan for pricing and in fact, slightly ahead.

So that's part of it, is the pricing gets rolled in.

In the first quarter, it's really not fully impacted, because we announced the pricing across a number of geographies.

I mean, in the EU alone, we're implementing pricing in Germany, Poland, Italy, France, I mean -- that we've mentioned the pricing in Russia.

As you know, Indonesia develops throughout the year.

We had pricing in the beginning of the year for Mexico, Canada, Argentina, Philippines, a big piece that's going to be now reflected throughout the rest of the year.

So that's part of it.

The volumes in the first quarter came in what we expected, maybe a little bit better.

The CC, the conventional cigarette volume, is actually holding up very nicely, and we're seeing some good developments in a number of markets despite some of the pricing-related volume impacts that we're having in Russia, in France and a couple of other markets.

But overall, we're doing pretty well on conventional cigarette volume and our outlook for that as well.

Okay.

On your outlook for incremental spend on iQOS, relative to, I believe, it was the $600 million in incremental spend you had originally guided for, how should we think about you guys kind of tweaking that plan?

Like what would drive adjustments there, given, in particular, the first quarter trends in Japan?

Yes, I mean, look, we're going to spend what we need to spend, particularly in Japan.

We have a rocket ship there that is absolutely taking off and very, very successful.

And we will put the resources into it that we need to and which we think is appropriate.

There are various ways to do that, right?

You can reallocate from the spending you have in other areas around conventional and other programs.

You can reallocate some geographically, or if necessary, we can also spend above that $600 million that we mention.

This is part of the reason we are holding back a bit of the tax benefits that we called out as far as our guidance increases, so that we have the flexibility and the ability to put the resources behind the very successful product that we have, not only in Japan, but elsewhere.

So yes, right now, we don't call out an increase in spending from the $600 million because first, we want to look at our reallocations and putting our heads together to put more resources where we need it without increasing the total net increase.

But at the end of the day, if we need to, we will spend what is necessary for these new initiatives in Japan.

And we'll find a way to deal with that within the guidelines that we've given you on the guidance.

Okay.

Last one for me, please.

As we think about that Rogers innovation adoption curve that you showed for Japanese consumers, like, where do you think it kind of breaks and you say, okay, you know what, like there's probably a saturation on iQOS and these older cohorts maybe are more appropriate for like a Platform 2. How are you guys thinking about that balance?

Well, I don't buy the idea that the late adopters or the -- even the laggards, won't move to heat-not-burn.

We see actually that individuals in those groups have very high conversion rates.

It just takes a bit harder, a bit more time to explain to them how it works, how to use it, what the benefits are and so forth.

I mean, we're reaching -- we're ever more mainstream with iQOS in Japan.

When you hit 16% market share, it's everywhere.

You see every -- people using it.

It becomes much more a product that can be considered by anybody.

It's just that it takes them maybe a bit more explaining, a little more training on how to use it, a little -- a different message on what are the benefits.

So we're not at all saying that iQOS won't be successful among the 50-plus or among those different groups that we flagged on the chart.

It's more a matter of how you approach them, what are the programs, what are the messages, which way can you communicate with them better, what are the products you put in front of them?

So we think that they are very still good potential consumers for iQOS.

Now could a Platform 2 over time also play a role in some of these markets?

Absolutely.

And we will, over time, as we get to that point, use the entire product portfolio to address both different consumer groups but also even individual consumers during different times of the day or different points where they might enjoy one product versus another.

We see our entire portfolio as something that can be used not only to approach different groups, but also within individuals where they might see some of these products as more relevant during certain times of the day or during parts of their week.

So anyway, we think we will continue to grow in Japan.

It's getting more mainstream, so it becomes a different approach.

You don't have the very fast word-of-mouth coming quite as fast from some of the early adopters and innovators, because almost all of them have already either moved to the category or tried the category.

We're reaching close to saturation in those groups, which is great news.

But we will tackle these other groups, and we will be successful with them.

We're quite convinced of that.

It's just how fast it goes.

Our next question comes from the line of Jon Leinster of Berenberg.

Just a couple of quick questions.

One, quite a specific one.

In Japan, just out of interest, how many of the devices are now sold at full price and how many are still being sold on discount when it comes to iQOS?

An increasing percentage is sold at full price, because the original design was that the discount was more for encouraging people to register and new users.

So you see consumers buying a second device, which is positive from the point of view that they are more attached to the category and they see a need for additional devices.

And you also see some replacements because, remember, we've been in Japan now for over 2.5 years.

So you have devices that reach the end of their number of cycles that need to be replaced.

Right now, in Japan, it's actually more than 50% is sold without the discount.

So it's moving slowly in that direction.

At the same time, we have to realize that to attract new consumers, especially getting back to the 50-plus age group, there's a little more price sensitivity in that group as well.

This group tends to buy brands which are a little bit lower priced, and so they are more sensitive, both on devices and on the HeatSticks.

So having a good offer for them and a good opportunity for them to try it, especially for their initial devices, is important to cracking that group.

So we'll be judicious how we use discounts, but I think we have to be realistic that we have competitors out there offering their heat-not-burn usually at 30% or 40% below the lowest prices we're offering for ours.

So we have to find ways to also put our products in front of people that are a little more price sensitive as we go forward.

Just to take that a bit further.

I mean, in the past, you've talked about potentially producing lower-priced brands, if HEETS is a sort of premium brand, and maybe producing a sort of more comparable in pricing terms with some of the competition.

Is that what you're referring to here, potentially a whole new brand?

Or you're referring to sort of just a more heavy discount on the existing brand?

Well, I think as you can understand, I'm not going to go into details for competitive reasons on our plans.

But in the long run, over the long haul, you're going to have to find ways to approach different consumer groups, and you can do that in many different ways.

You can do it with different products.

You can do it with different offers.

You can do it with special offers, et cetera.

So I'm not going to go through the exact plan.

But obviously, we're thinking about ways to crack different consumer groups, many of which are going to be increasingly price sensitive.

Another quick question on iQOS.

Clearly, the experience in Japan has been that the flavors, the menthol and so on were sort of most popular.

Is -- are you finding a very similar experience outside of Japan?

Or is the consumer reaction to iQOS perhaps to use the more -- the non-mentholated or non-flavored version, is that more traditional taste?

Yes, I mean, I think it depends on the market.

In markets that have a menthol category, the menthol version is usually preferred by menthol smokers, quite obviously.

Often, though, we do see the menthol over-indexes a bit, simply because it's a bit easier taste to bridge to from conventional to go to iQOS, because iQOS is a much lighter taste and it's a flavor that people have chosen in a bit higher percentage than usually the menthol in the market.

But it depends greatly on the different market and the different situations.

Right, okay.

So it does vary, the experience does vary by market quite considerably then.

Yes, it does.

Yes, quick one on the FMC side.

Am I reading this right, that volumes in Pakistan sort of doubled, and that added 8.4 billion units?

Is that correct?

Yes, there's a couple things going on in Pakistan.

First of all, if you recall in May of last year, we were successful in working with the government to establish a new tax tier, a lower tax tier, in order to pull back the volume that had been lost to illicit trade.

Because they had raised taxes so much and prices so much, and the illicit trade being actually local producers that weren't paying tax, had grown tremendously.

So in May of last year, this new lower tax tier was implemented, and we were able to put products there at a price that could pull volume back from illicit trade, together with the competition.

The second piece is in 2016, there was a big inventory load in the market associated with a big price and tax anticipated.

So in 2017 first quarter, there was very little volume sold or relatively low volume sold in the market.

So you're looking at 2 aspects.

One is volume coming back from illicit trade, which is roughly half of that 8 billion number you're mentioning.

And then the other half of it is the comparison year-over-year, which is an inventory effect from the very high volume sold in fourth quarter 2016 with a very low volume in first quarter 2017 to more normalcy in the first quarter of 2018.

So the market was quite distorted by both of those 2 events.

The good news in Pakistan is we do have the legal volume recovering substantially from what was a pretty dire situation, with illicit trade taking a lot of that volume out.

So that's a very positive development.

And our market share, by the way, in Pakistan has improved as well from this whole situation.

Okay.

And a very quick last one.

Are there any sort of patent lawsuits pending regarding any other competitors with -- on -- related to iQOS in terms of the design of the product?

Is there any legal proceedings outstanding for anybody against anybody in terms of sort of copyright?

Look, we work very hard to defend our intellectual property.

We constantly are looking at what competition is doing and looking at potential legal remedies in cases where we think they are misusing our IP.

But I'm not going to comment on individual cases or individual actions that we have, either pending or out there, at this time.

Our next question comes from the line of Chris Growe of Stifel.

I know we're nearing the end of the call here, I'll just be quick here with 2 questions.

The first is, can you say how much of the spending you plan for the first quarter has shifted into future quarters?

Is it as simple as the EPS beat that occurred in the quarter, does that get pushed into Q2 or spread across the next 3 quarters?

Yes, I mean, we flagged the difference between the $0.87 that we had forecast and the $1 was -- it's about $0.03 coming from the difference in the tax rate and the rest is overall spending-type stuff.

I mean, the business, by the way, was very good in the first quarter.

Revenues came in well.

Pricing is doing great.

So we had a good robust quarter.

But most of the difference is the tax and -- is actually the spending and then the tax.

We still think the spending will be the same, more or less, as what we said before.

So obviously, what we didn't spend in the first quarter, we still plan to spend in subsequent quarters.

I'm not going to give you the exact amount or the exact timing of it, partly because these plans are still unfolding and we're still allocating the resources and deciding which projects are most successful and deserve more funding and so forth.

Okay.

And then just to understand the construct of that spending.

You talked about spending more behind existing iQOS users in Japan, for example.

So is that taking away -- are you spending more, say, in Japan to retain customers and taking away from maybe new developments in other markets around the world as we think about the total, that $600 million of spending?

I'm not going to go through the exact regional split or country split.

All I'm trying to flag is that we will do what we need to do in Japan.

In other words, we're pulling forward some of our plans.

So in some cases, it's just timing of what we were planning to spend anyway.

And in other cases, we may need to put some additional resources in there, which we can fund in a number of different ways, including taking it from the conventional business.

It's a big company.

We have adequate resources to redeploy some to trouble spots or to get opportunities going, which is, I look at Japan as more as an opportunity.

But does that mean we're going to, for instance, cut spending in EU behind iQOS in order to do that?

I don't think so.

I think it's more an issue of figuring out what programs work and where to spend it and so forth.

So I'm not going to give you the exact split by the market and by the region, but we will do what we need to do to get iQOS fully successful, which it is doing already, and we need to continue it.

Our final question comes from the line of Judy Hong of Goldman Sachs.

I just had 2 quick questions.

One, I mean, obviously, your stock is down pretty meaningfully today.

Your ratings have gotten better.

You got in some cash overseas.

So I'm just wondering if you can revisit the share buyback earlier than perhaps you had envisioned.

And then secondly, just on Japan, I guess, the bigger question to me is whether you've just overestimated how big the market can get ultimately, and basically, we're already seeing market share kind of plateau, and it's not necessarily an early adoption issue, but that's basically how big the market can get.

So how do you get comfort around that there's actually a bigger demand out there?

Okay.

I mean, first of all, on the share buyback, we've said we won't have share buybacks in 2018.

We're working to improve our leverage and make sure we have the flexibility also within our balance sheet to be able to make, for example, acquisitions of new technology in the reduced-risk area if necessary.

If currency continues favorable or gets more favorable and stays that way and we continue to see the success in the business that we're having, at some point, we're going to have to sit down with the board and decide what's the best way to reward shareholders, whether that be dividend increases or whether it be stock buybacks.

It's really a board decision, and we haven't gotten to that point yet.

But at some point in the future, that will come.

As far as Japan, look, what we're seeing is that the conversion rates, for example, continue to be very strong.

We think that as we approach consumers and have the ability to talk to them and convince them of the product, that we can still continue to grow this category.

We don't think there's some artificial plateau that's a ceiling and we won't be able to grow beyond that.

We think it's more a matter of the speed at which it can move, the resources it will take to do it and the messages, tools, approaches, products that are customized to each of the different consumer groups to keep growing.

We don't buy the idea that somehow, there's a big chunk of consumers that want to continue using combustible cigarettes when offered extremely high-quality, satisfying reduced-risk products.

It just doesn't make sense.

Every single adult smoker that has the right product to shift to as a cleaner way to use nicotine, we think can eventually make that shift.

And we've seen it among our own employees.

We've seen it among every market where we go and work on it.

We've seen it among our friends where we go.

And we -- you approach somebody and convince them that this is a better way for them to use nicotine and get them to commit to using it for a certain period of time, the conversion rates are fantastic.

So we don't buy the idea that there's some sort of a limit.

It may take longer.

It may take more resources.

It may take more customized approach.

But this isn't an unforeseen.

We knew that we were going to have to adjust as we hit different consumer demographics and consumer groups.

And that's kind of where we are.

This isn't surprising.

Okay, it came a little bit earlier in the year than what we had hoped.

That's just how it is.

But that's okay.

We've got the right team and the right products and the right approach, and we're going to keep growing in Japan.

Thank you.

That was our final question.

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

Well, thank you very much for joining us.

This concludes our call for today.

And if you have any follow-up questions, please contact the IR team.

Have a great day.

Thank you.

Thank you, ladies and gentlemen.

This does conclude today's conference call.

You may now disconnect, and have a wonderful day.