菲利普莫里斯國際 (PM) 2012 Q3 法說會逐字稿

Good day and welcome to Philip Morris International third-quarter 2012 earnings conference call. Today's call is scheduled to last about one hour, including remarks by Phillip Morris International management and the question-and-answer session.

(Operator Instructions)

Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community. I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go-ahead, sir.

Welcome. Thank you for joining us.

Earlier today we issued a press release containing detailed information on our 2012 third-quarter results. You may access the release on our website at www.pmi.com. During our call today we will be talking about results for the third quarter 2012 and comparing them with the same period in 2011, unless otherwise stated. References to volumes are to PMI shipments. Industry volume and market shares are the latest data available from a number of internal and external sources. Organic volume refers to volume excluding acquisitions. Net revenues exclude excise taxes. Operating companies income, or OCI, is defined as operating income before general corporate expenses and the amortization of intangibles. You will find data tables showing adjustments to net revenues and OCI for currency, acquisitions, asset impairment, exit and other costs, free cash flow calculations, and adjustments to earnings-per-share, or EPS, as well as reconciliations to US GAAP measures at the end of today's webcast slides, which are posted on our website.

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. It's now my pleasure to introduce Jacek Olczak, our Chief Financial Officer. Jacek?

Thank you, Nick and welcome ladies and gentlemen. We remain confident that the fundamentals of our business are solid despite the difficult comparisons in the third quarter that we've previously discussed. We expect to achieve our annual organic volume growth target of 1% and adjusted diluted EPS growth in line with our near to long-term constant currency annual growth target for the full-year 2012. Today, we narrowed the range of our 2012 reported diluted earnings per share guidance to $5.12 to $5.18, compared to $4.85 in 2011. This guidance includes unfavorable currency of $0.23, a tax charge of $0.05 related to the closing of the US federal income tax audit for the years 2004 through 2006, and $0.02 of asset impairment and exit cost. Excluding the impact of currency, the aforementioned tax charge and asset impairment and exit cost, our guidance implies a growth rate of approximately 11% to 12%, compared to an adjusted diluted EPS of $4.88 in 2011. Let me remind you that if we exclude the $0.10 hurdle due to Japan in 2011, the growth rate would be even higher at 13.5% to 14.5%. Our revised guidance also reflects increased investments in marketing, sales and distribution, particularly in the Asia and EEMA regions.

Turning to our third-quarter results. We posted our strongest ever quarterly results this time last year with organic cigarette volume growth of 4.4% and adjusted diluted EPS up 33% on a currency neutral basis. As expected, therefore, our third-quarter results this year suffered from these very tough comparisons with organic cigarette volume down 1.3% and adjusted diluted EPS up only 5.8% on a currency neutral basis. For the end of September this year, we have achieved strong results with organic cigarette volume up by 0.7%. Excluding currency and acquisitions, our net revenues and adjusted OCI have increased by 5.4% and 6.9% respectively. Adjusted diluted EPS has grown on a currency neutral basis by 10.9%.

Let me now move to the European Union where economic conditions continue to be very difficult. Unemployment continues to rise in the South of European countries, most notably Spain. Consecutively, tax based cigarette volumes were down in the double-digit rate in the quarter in Greece, Spain, and Italy, while in contrast the decline in Germany was a much more moderate 2%. For the EU region as a whole , the decline was 7.5%, an improved trend compared to the second quarter and down 6.5% for the first nine months of the year. For the full-year 2012, we still expect that cigarette industry volume will decline by about 6%. A key component in the decline of the duty paid cigarette markets in southern Europe as been adult smokers switching to lower tax fine cut products and to illicit cigarettes. This can be illustrated by Italy where the duty paid cigarette industry volume declined by 10.1% during the third quarter, while fine cut grew by 41%. In addition, the incidence of non-domestic illicit trade for 2012 in Italy is expected to reach approximately 9%, up from an estimated 6.5% in 2011.

Our business performed very well in this difficult environment. Marlboro gained 0.8 points in the quarter to reach a cigarette market share of 23.5%. This was sufficient, along with the 0.4 share point gain by Philip Morris Selection, to more than offset the share of decline of our traditional local brand Diana. Overall, PMI's market rose by 0.2 points to 53.2%. We are now also the leader in the fine cut category and doubled our share to 27.2% behind Chesterfield and the launch of Diana.

In Germany, where unemployment remains low, cigarette industry volume declined just 2% in the third quarter, while sales of fine cut products increased by 2.3%. This robust trend took place despite tax-driven retail price increases earlier this year and were due in part to a reduction in border sales. Marlboro continues to gain share in the cigarette category in the third quarter, up 0.2 points to 21%. With L&M essentially stable at 10.2%, our overall cigarette market share was in line with 2011. In the EU region as a whole, economic conditions will remain difficult until the issue of unemployment is tackled. In the third quarter, our cigarette shipments declined by 8.1%, or 4.6 billion units, driven by the 7.5% decrease in the industry volume. Our fine cut volume in contrast increased by 15.2%. The drop in our cigarette volume can be in large part attributed to an increase in illicit trade, particularly in southern European countries where total tobacco smoking incidence levels have remained relatively stable.

We are very pleased by the performance of Marlboro in the quarter. In an obviously difficult environment for premium brands, Marlboro was able to expand its market share by 0.4 points to 18.4%. Marlboro share grew not only in Germany and Italy, but also in markets such as Belgium, Greece and in central Europe, notably Poland. L&M remained resilient despite the 0.2 share points decline to 6.5% attributable to adept smokers upgrading to Marlboro in Greece and Poland. Chesterfield gained 0.3 points to reach 3.5%, reinforcing our overall position in the low-price segment. Overall our cigarette market share remained stable at 38.1%, while we further expanded our position in fine cut adding 0.6 points to reach a category share of 13.4%.

Across the EU region our pricing remains strong; the latest increase having taken place this month in France. However, the positive pricing volume was insufficient to upset the volume decline. Net revenues and adjusted OCI, excluding currency, were consecutively down by 1.9% and 2.9% respectively. This also reflects the continued investments behind our brands and field sales force. In the first nine months of the year, adjusted OCI on the same basis has decreased by just 0.9% and we remain confident that we should be able to achieve an increase in profitability excluding currency in the EU region for the full-year 2012.

Our results in the Asia region were impacted by the difficult volume comparisons in Japan and Korea where our shipments grew by 47.1% and 22.4% respectively in the third quarter of 2011. We also faced challenging comparisons in Indonesia where we achieved a 22.5% volume increase in the third quarter of last year. Regardless, our volume this quarter in Indonesia grew by [one third of] 13% as we continued to increase our share in this growing market. Adjusted OCI, excluding currency and acquisitions, grew by 1.2% in the Asia region during the quarter, this despite the unfavorable geographic mix. And profitability in Indonesia and higher pricing across the region more than offset the impact of lower volumes in Japan and Korea. Importantly, our market share in Korea has sequentially improved from the second to third quarter of this year, and is at the higher-margin following our price increase in February 2012. Industry volume in Japan declined by 7.7% in the quarter compared to a very distorted third quarter last year when distributor and trade inventories had been replenished to ensure adequate stock levels following the events in Japan. Nevertheless, we still expect stable industry volume for the full-year 2012.

PMI's market share of 27.5% in the third quarter reflects a continued positive trend from Marlboro, which increased its quarterly share sequentially in 2012 to 12.5%. On a September year-to-date basis, PMI's market share of 27.8% remains nearly 3 share points higher than the level before the events unfolded in Japan last year. However, we have witnessed unusually high levels of competitive product introductions, which have put pressure on our traditional brands, Lark and Philip Morris. We continue to develop our innovation pipeline and expect Marlboro's positive momentum to continue. For the full year, we are now expecting our market share to be slightly below our 2011 exit share of approximately 28%.

Our leading position and our strong share momentum in Indonesia give us a unique position in the global tobacco industry. Market growth is expected to continue driven by favorable demographics. In addition, improving customer purchasing power is helping to drive up ratings with the premium segment reaching a share of 27.4% in the third quarter compared to 24.9% a year ago. In the third quarter, we witnessed a decline in the low-price segment where retail setting prices have increased at a faster rate than in other price segments. As a result, combined with the anticipated enforcement of Decree 191 by the end of November, which will eliminate a tax loophole, we expect industry volume to grow in the range of 6% to 7% for the full-year 2012. Our volume increased by a favorable 13% in the third quarter and market share grew by 3.3 points to 34.9% with a particularly strong performance from premium priced Sampoerna A in the product category and Marlboro in the white cigarette category.

Let me conclude the Asia region with an update on plain packaging. As you know, the Australian High Court ruled in August that the plain packaging legislation does not violate the Australian Constitution, and on October 5 issued its reasoning. In reaching a conclusion, six of the seven high court judges recognized that plain packaging deprives tobacco companies of valuable intellectual property. The conclusions of the high court are significant for other governments considering plain packaging as they demonstrate that plain packaging is a deprivation of property, something that we expect would raise serious questions about the legality of plain packaging legislation in other jurisdictions.

(inaudible) on this packaging is not unique nature of the Australian Constitution, which provides broad powers to the Commonwealth Parliament to make laws, but contains few protections for basic rights. Australian law is violated only if the government, as the taker of property, receives a proprietary benefit from that property. Despite the fact that the property was taken, the court found that the government did not acquire the property because it did not receive such a proprietary benefit. By contrast, the law in Europe and other countries is different. For example, in contrast to the Australian Constitution, the constitutions of the EU member states generally contain strong protections for fundamental rights and place limits on the powers of central government. A finding that manufacturers have been deprived of property would, in our view, amount to a violation of a number of EU member state laws. Due to the scope of the specific case, the Australian High Court did not rule on whether plain packaging would reduce smoking prevalence; however, plain packaging breaches Australia's international trade and treaty obligations. The High Court ruling confirms that other ongoing international legal cases are strong and that Australian government is at serious risk of having to face substantial compensation in these cases or bring displaying packaging measures into conformity with international treaties, or both.

Three countries have already initiated proceedings against Australia before the World Trade Organization on the ground that the plain packaging legislation is contrary to Australia's obligation as a WTO member. Philip Morris Asia is suing the Australian government for multiple breaches of its bilateral investment treaty with Hong Kong. Decisions in these cases are expected within two to three years. In broad terms, these cases will examine a number of issues including whether there is any valued evidence that plain packaging will reduce smoking rates, whether there are effective less restrictive alternatives that Australia could have implemented instead. Whether plain packaging breaches Australia's international trade and treaty obligations and whether the Australian government will need to pay compensation to Philip Morris. We believe that the international legal cases are strong and there is still a long way to go before all the legal questions about plain packaging are fully explored and resolved.

Let me now move to the Latin American and Canada region, which had solid share momentum in the third quarter. Although volume was down, we increased our share in the key markets of Argentina, Brazil, Colombia, and Mexico. Marlboro was particularly strong across the region, with share up in Brazil, Colombia, and Mexico. Excluding currency, adjusted OCI increased by 10.5% in the third quarter. The EEMA region was our strongest performer in the quarter, this despite the challenging comparison. Volume grew by 3% with continued strong business momentum in Russia and Turkey, as well as an improving market climate in Egypt. Higher volumes, a favorable mix, and pricing in Russia and many other markets, resulted in a growth in adjustable OCI, excluding currency and acquisition, of 17.3%. This is the sixth consecutive quarter that our volume mix has been favorable in the EEMA region. Russia was a key driver of our strong EEMA region performance, both in terms of volume and pricing.

In July, we implemented the tax driven RUB3 per pack price increase. Along with lower revised estimates for industry volume in the first half of the year and higher prices in the market, industry volume is now expected to show a slight decline for the full-year 2012. Our volume in contrast increased by 4.5% in the quarter thanks to our good share momentum as well as some favorable inventory adjustment. Our near term market share on a quarter and year-to-date basis through the end of August was 0.7 points and 0.6 points higher at 26.5% and 26.2% respectively. Parliament, Bond Street and Next have remained the key drivers of our stronger share performance. We are also pleased that L&M's turnaround is gaining momentum with a 0.2 share point gain in the first months of the quarter.

In Russia, the government approved amendments to the tax code at the end of September, including excise tax rates for the period 2013 through 2015. The government has reconfirmed the excise tax rates for cigarettes in 2013 and 2014, and extended the tax code to 2015 with a taxation of the specific excise tax set at 20%. Duma will now review the codes by mid November and we expect a final vote by year-end.

On a year to date September basis, Marlboro grew share in all four regions, benefiting from a robust pipeline of innovative products. Marlboro's share increased notably in Argentina, Germany, Indonesia, Italy, Mexico, and Poland. On a worldwide basis, excluding China and the USA, the brand's share increased to 9.3%. While we are pleased by Marlboro's strong performance, we are even more delighted by Parliament in the past three segments. Parliament volume increased by 10.7% in the third quarter and by 9.4% so far this year. The brand has gained share year-to-date in four of its most important markets and is making inroads in newer markets. In Turkey, Parliament achieved a market share of 8.7%, representing a gain of 0.8 points August year to date.

We continue to expand our market share in our top 30 OCI markets. Our September-year to date share reached 37%; this is 0.4 points above our full-year 2011 share and 1.5 points above our full-year 2012 share. The pricing environment continues to be favorable. This is highlighted by the $505 million in pricing volumes that we achieved in the third quarter and the $1.3 billion year-to-date. The combination of strong pricing, limited input cost increases and productivity savings has enabled us to continue to grow our superior adjusted OCI margins. On a PMI wide basis, our adjusted OCI margin, excluding currency and acquisitions, reached 46.2%, a gain of 0.7 points in the first nine months of the year. On a September year-to-date basis, our free cash flow reached $7.1 billion. Compared to the previous year, free cash flow excluding currency was down $1.7 billion, or 18.6%. The decrease was driven by higher working capital requirements, mainly related to finished goods firstly and the planned replenishment of tobacco leaf and clove inventories. For the full-year 2012, we expect that our free cash flow, excluding currency, will be down slightly and will not adversely impact our dividend and share repurchase program.

Our confidence is the underlying strength of the business and our ability to continue to generate significant cash flow is reflected in the 10.4% increase in our dividend that was announced last month. Since the March 2008 spin off, we have raised the dividend five times increasing the annualized dividend by almost 85% over the period. We spent $1.5 billion to repurchase a further 16.7 million shares in the third quarter. Since the spin off, we have now used almost $26 billion to repurchase nearly 467 million shares at an average price of $55.49. We continue to target spending of $6 billion this year.

In conclusion, the third quarter of 2012 was as expected a difficult quarter in terms of comparisons with last year's record third quarter. Looking at our performance year to date through September, we remain confident that for the full-year 2012 we should be able to deliver another 1% organic volume annual growth target, driven by strong performances in the Asia and EEMA regions. We narrowed the range of our 2012 reported diluted EPS guidance to $5.12 to $5.18, excluding the impact of currency, a tax charge and asset impairment and exit costs, our guidance implies a growth rate of approximately 11% to 12%. Finally, we remain steadfast in our commitment to deliver superior returns to our shareholders evidenced by the fifth consecutive increase in our dividend since the spin and our $6 billion target for share repurchases this year.

Thank you, and I will be happy to answer your questions.

(Operator Instructions)

Judy Hong, Goldman Sachs.

First, in terms of guidance, there is a lot of confusion in terms of your guidance update. So, if we look at the reported guidance, now $5.12 to $5.18, and compare that versus your prior guidance of $5.10 to $5.20, at the midpoint it doesn't look like it's changed a whole lot, but you basically have taken the underlying guidance up, currency's a little bit more favorable. Can you just bridge the guidance from $5.10 to $5.20, to $5.12 to $5.18, both underlying and currency, and et cetera?

Good morning, Judy. Yes, I think I start with our previous guidance, which was $5.10 to $5.20, and remember at that time, this guidance included the $0.27 of unfavorable currency versus 2011. Our new guidance assumes the $0.23 of unfavorable currency, a gain versus 2011, so we have a gain of $0.04 on the currency. Also in our previous guidance, we did not have the impact of the tax charge of the $0.05 related to the closing of the US tax audit and the $0.01 for adjusted impairment and exit cost. So, it gives me a $0.06, or gives us $0.06 of adjustment, if you like.

If I had $0.05 adjusted for better currency of $0.04, adjusted for the tax charge negative $0.06, I am at the -- we were at the $5.08 to $5.18, which we narrowed upwards, if you like, to the $5.12, $5.18. And this should imply a growth rate on ex-currency basis of approximately, as we said, 11% to 12% versus the adjusted diluted EPS of $4.80 in the previous year. I think it should be clear now.

Okay, so when you think about 2013, and you think about your long-term growth target of 10% to 12% growth, would you be targeting to grow off of the $5.12 to $5.18, or the $5.18 to $5.24?

For this year would be $5.18 to $5.24. Actually you should say $5.19 to $5.25. Not to further complicate the issue, we had $0.01 of adjustments in the first two quarters of the year, and the $0.01 extra of the adjustment for the exit and restructuring in the third quarter. So, to be perfectly accurate, I should say it is $5.19 to $5.25.

Which is the base that you would target the 10% to 12% off for next year?

That is correct.

Thank you. And in terms of EU, Jacek, it sounds like you are expecting some recovery in fourth quarter just versus what you've been seeing year to date. So, can you just walk us through why you are thinking that you do get some nice bounce back in fourth quarter to get to that full year down 6% for EU?

I think it is partially due to the comps which we expect for the Q4 this year versus Q4 last year. We had a very bad, very low quarter, driven by some timing of the pricing tax changes in the last year. So, we expect this to ease the pressure for this year.

And also, we see how the quarter three, which was very low -- sorry, quarter two, which was very low for EU, and in quarter three we closed, hoping this would give us the confidence that we should be in a range of 6% even, I would say marginally the volumes for the total market in EU may go a little bit below 6%. Let's say 6% is what we forecast.

Okay, got it. Thank you.

Bonnie Herzog, Wells Fargo.

My first question is on Japan. As you discussed, you've put a lot of new products in the market, so could you talk about how you're balancing this innovation while maintaining strength with some of your core brands in the country? Also, could you give us some more color on the competitive pressures, and how you see this playing out next year, especially in light of Japan Tobacco's plans to change their Mild Seven brand name?

Okay. As we said, or I said in our remarks, we are very pleased with the performance of Marlboro, which not only is obviously above the level which it had before the special situations in Japan, but also up sequentially every quarter of this year Marlboro has had higher share. Our focus since the beginning of the year was essentially primarily on Marlboro. So, four out of five of the big new initiatives which we have deployed into the market were behind Marlboro. Two behind Marlboro Ice Blast and two behind Marlboro Edge. The most growing or the most dynamic segment today in Japan is around menthol, super slim propositions, and they are sometimes with the capsules, with the menthol capsules, and this is exactly what we were pushing behind Marlboro.

JT, because I was referring mainly as the competitor deploying quite a large amount of new initiatives into market, seems like they took a little bit of a different approach. Their focus was broadly on their entire portfolio. So, clearly there are some brands which are more on the traditional spectrum of the consumers, and hence the losses which we incurred in the quarter of this year on more of our traditional brands, which is Lark.

Marlboro has been in very good shape. I think the innovations behind Marlboro -- what we already deployed this year, and what we have in the pipeline for the next year, I think we are in good shape. It is more that the focus of a JT and deploying a number of innovations there, hence our share is a little bit below the 28% exit share.

Now, with regards to Mevius and Mild Seven, it is difficult for me to comment on a competitor's move. It is clearly a very bold and a brave move. It creates some challenges presumably for JT, and creates, I would argue, some opportunities for others. Let's see how that thing's going to unfold in the market.

Okay, that is helpful. And then I have another question and it would be on Russia. How are you guys going to manage the scenario where there likely will be increased regulations, smoking bans, and then taxes. What are your expectations for consumption in the market, and consumer behavior if these proposals are enacted? And then, could you give us just a little bit more color on the progress you're making with Marlboro in Russia?

Okay, so on the tax in Russia, I think first we are very pleased that the Russian government continues with their three-year tax outlook. We always think it was good from a government perspective from their revenues, and also from the industry, a large perspective to have a three-year tax visibility, adding the 2015 and clarifying what rates they would like to have is very helpful. Now, clearly the reason -- there will be a substantial tax increase in the 2013, '14 and in '15, but something which we planned, or you could say we anticipated. So, I think at the end of the day, it's going to turn manageable on the tax side. On the regulatory side -- this tax, just for us all to understand, still needs to be approved by the Duma. This is not the final thing, but this is what we know at this point in time.

In terms of the regulatory, they have three issues of the three subjects which they want to cover for the regulatory that we understand today. The cabinet approved, and moved it now to Duma for Duma debate. It is a smoking ban for the hotel sector, the hotels and restaurants, which I think they are targeting 2015 as implementation, so it's not 2013, '14, it is '15, and the work places ban, which is 2013, next year.

Then you have some restrictions on sales in the outlets below the 50 square meters, so that clearly will have some impact on the volume allocations between the trade channels. And the experience from other markets is that -- it makes it a little bit more for customers to walk a few extra hundred meters to the next shop, but doesn't impact the smoking rate of consumption.

As is essentially the smoking ban. Because if I go to the more mature markets where in most of the countries on the planet in the world who have a smoking ban, you have an impact of 1% to 2% at the beginning of the after-peak implementation, and then the market moderates, it sometimes even comes back to the previous level. So, I think it is overall pretty manageable situations, but we need to assume that Russia is moving to that sort of the total market performance when you are serving a more mature country. So, maybe 1%, maybe 2% total of their -- of the total industry decline.

Okay, that makes a lot of sense. Thank you.

David Adelman, Morgan Stanley.

Jacek, can you hear me?

Yes.

Hello. First, Jacek, could you help me understand the magnitude of the negative effect you had in the Asian division from the year ago increase in trade inventories?

Yes, I think you are referring mostly to Japan.

Yes, in Japan.

Okay. So, Japan situation was like this, we had what we announced at the end of the year, we had what we called the hurdle in Japan, the 6.3 billion units or the equivalent was the $0.10 on EPS. This was related to the hurdle which we had in the second quarter, mainly in the second quarter of last year. Okay, due to the higher in-market sales and higher market share.

What we have been confronted with in the third quarter of last year is that, obviously, following the high sales in the second quarter, we ended up with extremely low inventories at the trade level. We have to replenish this inventory to the safety level. That is essentially where the distortion comes from. And if you would need a quantification of the thing, I think the adjustments would be in the range of, say, about the 1 billion units for Philip Morris. You're talking about that sort of a distortions, which we have to take and we would have to replenish inventories to the safety level.

Okay. And then secondly, Jacek, in the EU, you obviously had run that division. What's the midterm outlook for Philip Morris in the EU? Do you think it is reasonable that for the foreseeable future that you can maintain local currency operating income? Do you think that that is an ambitious objective, or do you think despite the economic situation, the unemployment levels and so forth, you can continue to eke out a little bit of growth over time?

We managed to maintain, if not actually we expected we can even slightly grow the profitability on a net currency basis this year. So, yes, it is ambitious. Obviously, there was a huge effort. You see what we are doing with Marlboro and how it nicely plays back, how we are guiding rapidly to the (inaudible) segment. Obviously, we're trying to manage and mitigate the impact of that crisis.

Until you see the improvement on unemployment side very much in the south of Europe, because this [affects] the performance over the entire year, and I hardly can see how the situations can improve. But we are already targeted in a crisis, I am talking Philip Morris, and we managed the situations pretty well. So, unless they are in a shocking type of excise increases, which we don't see today at all, I think the situation is very challenging, and we all know it, but I think it is manageable.

Okay. Two other quick things, Jacek. The resignation of the EU health minister, do you think that is going to have any effect on the outcome or the timing of the pending update of the tobacco products directive?

Already the EU should be today after the inter-service consultation. There were some delays before the departure of Mr. Dalli. We have learned about the new development, the sudden departure, and we hope that the EU commission will have a transparent, evidence-based process while reviewing this directive. But at this stage, we do not know how the departure of Mr. Dalli will impact the timing of the typical review. This is a development over the last couple of days literally.

Okay. And then lastly, Jacek, on working capital, is the build or the use of cash flow for inventories and so forth this year, is that a one-off phenomenon? Is that going to be a negligible number next year, or will there be a working capital build next year in all likelihood, as well, but it will be considerably less than this year? Or do you envision a similar level of incremental use of cash for working capital next year?

Okay, yes, there are three elements which are the three key drivers behind the working capital developments this year. One is the [forestalling] inventory, and this is a variable which depends on the timing and the level of the tax price changes. So, that will remain, but I can't give you the magnitude because this we don't know, frankly speaking. The two others is the inventory of leaf, level of inventory of leaf, and inventory of clove. Here the situation is a little bit different because we had a very high level of sales also driven by Japan last year, and now our inventory has to be adjusted.

We finished the inventories in 2011 at a little bit lower level because we used that leaf in our cigarettes which we sold last year. We continue with the high volume this year, and you see that we are shooting still at the 1% organic volume growth target. So, I will continue to need to rebuild my leaf inventory, which is a good thing because I'm using this to support myself. Clove is a little bit different thing because it is a cyclical crop, and this year I have a very high crop at much more attractive prices than the previous year. So, I have no choice, actually we are doing what everyone should do, we have to buy clove when it is in the big supply at the right prices.

Okay.

So, clove presumably may ease a little bit next year, but the rest we will have to see.

Okay, fine. Thank you very much.

Erik Bloomquist, Berenberg Bank.

Can you hear me?

Yes.

Hello. If I could follow-up on the question on the European Union tobacco products directive. Is there any clearer sense -- I understand the timing issue, but in terms of what we should be expecting as major initiatives embedded within that? And then secondly, on the Philippines, I noted that market share losses and the citation that that was driven by Champion and Hope. I wonder if you could talk about what happened there? And then secondarily, the prospects for the tax law change, given the changes in the Senate and the various options going on there? Thank you.

Okay, Erik, on the TPD, as I answered the previous question, it is hard to say today what the outcome in terms of the timing is going to be. We have not much of the visibility what is in a draft directive. As I said, the inter-service consultation should already be at the end, and it has not started yet. Clearly, the ideas of the proposals there attract a lot of attention and, therefore, the draft proposal is not issued yet. So, we just have to be patient and wait for this one.

Moving to Philippines, yes, we had to think about the 2 points of the market share loss in the quarter in Philippines that is driven by the low price at the bottom of the market. We had some pressure from, I think, one of the competitors. We know that there are some distortions due to the fact that some competitors are charging prices which is difficult to reconcile if somebody would pay the full excise. So, I think there is a bit of a tax loophole or that sort of a nature problem. We have adjusted in some regions, I think the price of a Champion, so we are defending our position. But other than that, we're doing okay. Marlboro was up, Fortune was up, so I think that is the only problem which we have [on our side].

With regards to the tax, I think the Senate just now or next week goes into recess. I don't think the Senate has yet issued or concluded with [day bill]. It depends on how much the Senate will be different to the House of Representatives Bill. They will have their bicameral conference committee when they will reconcile the differences. I think we need to wait until the end of November to have a tax visibility for Philippines.

Okay, thank you. And then, with respect to the Swedish Match JV, I understand that the JV is now in Israel. Could you comment on what that market offers in terms of additional understanding of consumers, and what the prospects are also in St. Petersburg? Thank you.

We have, I think, four test markets with the joint venture, where we are testing the product. We are trying to understand what is the right way of marketing that product to adult consumers, the whole behavioral part of the thing, et cetera. It is a long-term project. I wouldn't go into the specifics of each individual test; it is a step-by-step learning how to promote this category.

Okay, thank you.

Jon Fell, Deutsche Bank.

I was just wondering if we could delve a little bit more into Italy. I'm sorry the line wasn't that good. But first of all, did you say that illicit trade had picked up from about 6.5 to 9; was that the correct figure?

That was the correct figure.

So, we've got a 2% or 3% legal market decline stemming from that. What sort of shift out of factory-made cigarettes would that fine cut growth have caused?

The fine cut grew, we said, by about 40 -- above the 40%. I think about 50% of the volume decline in Italy would be due to the price elasticity, and the 50% would be somehow almost equally distributed between the fine cut and the illicit trade.

You will have to zoom into the geography in Italy, because there is a lot of growth of contraband in the south of Italy. There are towns now which last year had contraband below 10%, and this year they have a 50%. Obviously, I can throw you the names of Naples in Palermo (technical difficulties), but that is what is happening there. But that is about I think would be the first of the fair distribution of the losses, if you like, in Italy. About 50% is due to the elasticity, and the remaining 50% in equal parts would be about illicit trade, in effect.

Okay, thanks. Can you give us a rough idea of what the annual increase in prices has been in Italy, third quarter versus third quarter last year?

I would have to go -- okay, this year I think we had a March $0.10, $0.10 per pack. And this last year you had September $0.20 and July $0.10. So, I think year-on-year basis [about] to finish at the end of this quarter we had a $0.40 price increase, on a year-to-date basis.

Okay, and what is a pack of Marlboro now in Italy, about EUR6?

Yes.

Okay, thank you. (multiple speakers). EUR5, okay. And then in terms of the rough breakdown of those effects, illicit and OTP, are we talking something pretty similar in Spain basically?

Yes, it is a different stage of the market because Spain is longer in the crisis, but again, you have growth of illicit trade, comparable developments, and the growth of the fine cut.

Okay, thanks very much.

Thilo Wrede, Jefferies.

Jacek, can you elaborate a little bit on your views about slowdown of economies in Asia in particular, and what impact that could have on market volume growth, on up-trading versus down-trading, on your ability to take pricing?

Yes, okay, I think the biggest slowdown is what [originated] in China, so for the time being it is not impacted directly. But you take -- and you looking at Indonesia, there is a slowdown and it is still expected that the economy to grow 6% to 6.5%, highest I think consumer confidence, moderate inflation. So Indonesia, which is a big market for us, I don't think we have any sort of the headwinds there. Philippines, we have this open tax issue, but other than that I think there is underlying economy is not really that bad. As I said, and I don't want to downplay what we read, but I think it is a much more coming from China, and China, as I said, for time being, does not have that much of an impact on us.

And you don't see any risk that China could spill over into other Asian emerging markets, as well?

Well, I see the forecast today, as I said. In a big, large market for us, Philippines, Indonesia, Japan is a different story. But even in Japan this year, following distortions, et cetera, we estimate about a flat market. I think we should be okay.

In Indonesia we think the market is going to grow in the range of 6% to 7%. I think that earlier this year we talked about 8%. Actually if I look at the composition of the mix in the market because there is a lot of up-trading, I think the value of the market goes better with a 6% to 7% volume growth assumptions that which we had previously. So, not today. I mean, today I don't see the impact.

Okay. And then in Japan, it seems like Japan Tobacco has been, for lack of a better word, out-innovating you for two or three quarters now. Do you expect JT -- at what point do you expect JT to slow down their innovations, or at what point would you have to step up your innovations for the market?

Well, I don't think -- I wouldn't say that they over-innovate us. I think it is not that they have innovation in terms of the benefit offer to the adult smokers, which is better than ours. I wouldn't say like this. It is just a number of the launches which they did in the last three quarters. Not on the quality, more on the quantity. I am not in the Switzerland office, I can't comment on visibility, when they will stop launching more products.

But right now you don't see any need for you to change your innovation approach in Japan?

No, we still have -- we just launched this week, I believe, Virginia Slims, so we are moving to other brands where we have a pipeline of initiatives to also prepare. I think each of these initiatives has to be launched properly into the market, and we need the time to work it with the consumer. Throwing too many things in too short a period of time, in the long run, it is not Philip Morris approach.

All right, I appreciate it. Thank you, Jacek.

Chris Growe, Stifel Nicolaus.

Just had a couple of questions for you, if I could, and they are mostly just follow-ups. I wanted to ask you a quick follow-up on Japan, which is -- what is the underlying decline rate you expect for that market this year? If you said that, I missed that, I'm sorry.

No, for this year I think we estimate the market to be flat versus last year. So, I think we now estimate the market should close at about 195 billion, 196 billion units.

So, therefore, the decline this quarter was not unique or different from what you expected?

No, because you had -- as I said, I think with the replenishment of inventories, which I quantified for us to be about 1 billion, and I think on the total market, the estimate would be in a range of 3 billion, the third quarter last year. I think if you factor this in, you'll come to the more of the normal situation.

Okay. Thank you. And then I wanted to ask about Russia. There was a comment about some inventory movements this quarter, and so is there a way to quantify how much that helped your shipments in the quarter? And then related to that, I know you've had a better share there that is coming from brands other than Marlboro, and I know you have some new products behind Marlboro, so just curious if you could comment on that and the state of Marlboro in Russia?

Okay, I think the impact on the shipment was, I said, we said it was coming from inventories, but we also have a very strong share growth in Russia. And this is behind all brands not at this stage by Marlboro. Now Marlboro, yes, we have launched Clear Taste, I mean the extensions of Marlboro family into the Clear Taste.

I think on Marlboro, maybe I should put it like this. Marlboro is for us a [mid term journey] and we have three issues which we have to continue addressing with regard to the Marlboro and their performance versus our standards in Russia. One is the premiumness of Marlboro, which we are trying to correct with pricing Marlboro higher than it used to be. The last two price increases, Marlboro actually took a bit more of the price increase that was the increase in the market.

Second thing is Marlboro has an issue of harsh perception, and this is what we are addressing as we speak with the launch of Marlboro Clear Taste. And the third one is the modernity side of a Marlboro, and we continue this with our marketing programs in place. I think we are making progress, but in order to claim that we have a sustainable growth of Marlboro in Russia, I think we need to be a little bit patient, and we are patient.

Okay, and I have one final question for you, and that is -- in relation to the EU region, it is going to be your third year of roughly 5% to 6% declines in volume, and it's difficult to predict the state of southern Europe and some of those countries. Looking ahead, whether it be one year, or one to three years, is the -- obviously the risk in those markets where you've had this increase in illicit trade such that you could continue to see those kind of declines in the EU region overall. My question is just related to the illicit trade, and if that's becoming a -- obviously a larger and larger issue in some of these markets?

Every single government is getting focused -- has the right focus now on the illicit trade. It is just we are living with the consequences of, in some countries, high tax increases in the past, and also the sudden erosion of the consumer purchasing power because all of these austerity measures dented what the consumer has in their pockets. I think I said in the remarks, if I look in Germany, when we see the markets doing very well, quarter three was pretty strong, and we're still looking for the full good year of total industry volumes in Germany. I think that's partially because the illicit trade comes back, at least to some extent to the legal market.

I think what we confronted today in the south of Europe, one day these volumes, at least to some extent, will come back to the tax paid volumes, to the industry volumes. But as I said, unless you see the improvement in unemployment, I don't think we should be betting on any type of improvement in EU.

Okay, thank you for your time.

Rogerio Fujimori, Credit Suisse.

Could you just let us know if there was any news in Turkey with regards to the excise tax reform?

No. Well, the only news which we had is that, I think, the government has already increased taxes on alcohol, fuel, and some other categories. So, frankly speaking, I would expect the announcement of a tax increase or tax change in Turkey somewhere before the year-end or at the very beginning of the next year. You know that the government has received authorization from the parliament to implement a specific component. This will be the first time historically when Turkey will have a specific component, but we need to see the announcement of the government.

One question about France, could you talk a little bit about your thoughts on the outlook? I appreciate that Marlboro has been outwardly impacted by crossing the EUR6 per pack price, but any thoughts on the market would be appreciated? Thanks very much.

Well, the market, I think, for the quarter was down a little bit less than a 5%, 4.5% or 4.6%. Year to date, I think the market is about 4.2% down. We now had the price increase of EUR0.40, so Marlboro went from EUR6.20 to EUR6.60, but the low-price cigarettes went from the EUR5.7 to EUR6.10, so somehow there is psychological price point barrier is removed, but you know that the prices are higher in the market.

So, I think Marlboro had more of the pressure being alone about the EUR6. This is somehow removed. But the whole prices are higher in the market, so we will see how it develops. You hear about some austerity measures in France taking place and so on, so I think we need to see how that thing materialized and what impact it will have.

That's good. And just one final question about the Ukraine. I understand there was some trending in trade movements in the quarter, but I was just wondering if trading conditions in Ukraine sequentially have changed relative to the first half? Thank you.

I think there was some distortions due to the Q3 in the 2011 in Ukraine. So, the market was looking -- was I think 10% lower in Q3 this year, but I think it was very much driven by some distortions in the Q3 [inventory] level. On a year-to-date basis, it is presumably better -- better number for Ukraine, it is 3.5%, and I think we estimate that the full year will be in the range of about 3%, full-year total industry volumes.

Thank you very much.

Vivien Azer, Citi.

I wanted to circle back to the Philippines. While I recognize it is still early in terms of the legislation that is coming out of the Senate and the House in terms of the excise taxes, I was curious if you could at least comment on the price elasticities in that market, and how they compare to other emerging markets?

Well, the markets, total markets -- this year we estimate the full-year total market will actually cross the 100 billion units. I think we estimate like 101 billion units, so this would represent, I think, close to the 3% growth of the market. The recent price increase we took in the market of -- today the elasticities will be in the range which you've seen other places. If you're asking me the question -- how we see that thing post the tax implementation, then I need to know what is the tax which final will be implemented there. That's a little bit of a speculation [of this case]. I don't know if I answered the question. This year I think the market is in -- will grow in the range of up to 3%. This is our estimate.

Okay, fair enough. And in terms of the EU, given the outsize growth that you saw in other tobacco products, while those are definitely lower margin, I was curious, at least directionally, what your organic profit growth would've looked like on just a cigarette basis?

We are entering the fine cut because consumers have preferences for usage of cigarette brands. (inaudible) rapid share advancement in this category. The fine cut has a lower unit profitability than a cigarette, but it is also within the current tax structures. The government, some governments are looking into restructuring of the tax on the fine cut, et cetera. It is an important element, and it is becoming an important element, not in terms of our profitability but overall, if you like, service which we are delivering to the consumers. This is how we look at that thing. Part of this volumes, I also think will one day come back to the manufacture to cigarettes.

Okay, fair enough. Thank you very much.

Chris Ferrara, BofA Merrill Lynch.

Can you talk a little bit about EEMA pricing? Obviously, pricing was good but margins really took a jump. I understand you took the price increase in Russia, but is there anything else in there that would've driven pricing and margin up that significantly? And can I get you to talk a little bit about the sustainability of these margins, because I think they are the highest, on a quarterly basis anyway, we've seen in a while.

I think we've had some pricing in Ukraine, as well. So, it's not just Russia which drives the -- Turkey. It's not just the Russia in EEMA which drives the pricing. In sustainability of the thing, yes, I think in general we say that the pricing environment seems manageable, favorable, and we have seen how much -- we had a pricing volumes year-to-date on a global basis, and I think that is going to continue. Yes.

Thanks, and one quick thing on the EU, I think you've been clear that without unemployment getting fixed, that market continues to decline. Can you just talk about the ability to continue time after time to generate that 1% volume growth for the total company with an EU drag of 6%? Can you just put a little color around your ability to keep doing that?

Well, I think that this year is going to be the perfect stimulant that this is achievable, because we have EU when we predict the total industry volumes to go down by 6%. And despite even the difficult comps in Asia, we say that the PMI can deliver 1% organic volume growth targets. I think the engines in EEMA and Asia are working at the full throttle, and they can cover up for the challenging environment which we unfortunately have in EU. I feel pretty okay about it.

Got it, thank you.

Michael Lavery, CLSA.

Thank you. I just wanted to touch on illicit trade. I know you've outlined the size of that opportunity in a lot of markets, but it seems like it rarely goes down. It did in Turkey this quarter; what were some of the drivers there? Is there any color you can give on what would've helped that?

Well, as far as the government focus, and it is not just the Ministry of Finance or customs authorities, but it was, as I understand, a number of ministries and state agencies which finally sat together and decided to do something about it. And to their credit, they did a phenomenal job. I think the situations of the tensions in the Turkey/Syria border also helping a little bit. There's obviously more intensity of the border controls, et cetera. So, those are the key drivers. I think the government, which seems to be committed to address the issue of [contraband in a Syria vote].

Okay, thanks. And then back to Russia, I know we've covered a lot of stuff here; I just want to make sure I understand exactly what you were saying. If the tax increase is approved by the Duma as it stands now, and not as it's written, are you saying that that would be manageable, or would you characterize that as a disruptive tax increase? Or just at least looking from this year to next, what is the magnitude of that, in your opinion?

Well, the magnitude of the thinking in terms, if it stays as it is proposed by the government now, the next year this will translate into the pass on, theoretical pass on about I think RUB6, and year after of about RUB9. If you take the pricing in Russia, you take the inflation, it is an increase, it is not a minor increase. But as I said, I think substantial but manageable. But this is not disruptive tax increase.

And so, the positive is obviously that it is laid out over a multi-year progression, and you would have the predictability, but how big of a risk do you see for next year if that goes through as proposed now?

Well, this is the second year in a row where we have a three-year tax visibility. There are more governments, not only Russia, going to that sort of an approach. In Germany and other places where they want to see three-, four-, five-year tax outlook set at the rates, and that is clearly demonstrates that there is also benefit for the governments in doing so.

Okay, and then one last question, a little different. I know at the analyst day you laid out a lot of great stuff about the next generation products, but clearly it takes a little bit of time to commercialize those and get the approvals that you are looking for. Given the success of e-cigarettes in the US, would you consider doing -- putting those in the market anywhere? I know you were clear about how the nicotine delivery is nowhere near as comparable, but to the extent that there seems to be a consumer acceptance, at least in the market here, would that change how you think about doing that as maybe sort of an interim step?

No, our strategy is very clear on this one. We want to commercialize this product, but with a claim. So, I need the regulatory approval to allow me to say what the product, which we have, one of the three platforms which we are working on, can provide in terms of a benefit to a consumer. So, we don't want to make a shortcut on this one. I launch the product, which we have, but without being able to make the claim. I think that's very important.

Okay, thank you very much.

Ann Gurkin, Davenport.

I wanted to ask you about pricing, which year to date has been a strong contributor to results, and how should we think about the pricing lever for fiscal 2013?

Well, I am afraid I can't share it with you. But historically, if you look at since the spin off, our pricing volumes were in the range of $1.6 billion, $1.8 billion. And I think we don't see that much of a headwind, and so pricing stays intact, and is and will remain an important component of our growth model.

Perfect. And then, as we think about marketing spending and brand support, are there any changes in that strategy, either by market or by brand as you look out the next couple of months? Anything you can comment on?

No, we continue spending. We have a great growth volume and a share momentum. Last year, this year, and also behind the Marlboro and above premium Parliament, and I think it is very wise to continue that spending. So, we are going to continue, even in the difficult environments like EU or other places.

Great, thank you.

Thank you. I would now like to return the call to management for any closing remarks.

Well, thank you very much for joining us. That concludes our call today. If you have any follow-up questions, please contact the IR team, investor relations team here in Lausanne. Thank you again, and have a nice day.

Thank you, that does conclude the Phillip Morris International third-quarter 2012 earnings conference call. You may now disconnect.