Philip Morris International Inc (PM) — Q2 2015 Transcript

Welcome and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2015 second quarter results. You may access the release on our website at www.pmi.com. During our call today, we will be talking about results for the second quarter of 2015 and comparing them to the same periods in 2014, unless otherwise stated. A glossary of terms, data tables showing adjustments to net revenues and OCI for currency and acquisitions, asset impairment, exit, and other costs, free cash flow calculations, and adjustments to earnings per share or EPS, as well as reconciliations to U.S. GAAP measures are at the end of today’s webcast slides, which are posted on our website. Reduced-risk products or RRPs is the term we use to refer to products with the potential to reduce individual risk and population harm in comparison to smoking combustible cigarettes. Today’s remarks 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 Jacek Olczak, our Chief Financial Officer. Jacek?

Thank you, Nick. And welcome ladies and gentlemen. Our excellent start to the year was reinforced in the second quarter. Organic cigarette volume was strong, declining by a modest 1.4% due to lower cigarette industry volume across all regions, partly offset by market share gains in Asia, EEMA, and the Latin America and Canada region. On a June year-to-date basis, our organic cigarette volume was essentially flat or down by approximately 1% excluding inventory movements. For 2015, we forecast an organic cigarette volume decline in the range of 1% to 1.5%. Net revenues and adjusted OCI in the quarter were up by 4.5% and 6.1% respectively, excluding currency and acquisitions. This growth was driven by strong pricing across all regions, partially offset by lower volume, largely in the Asia and EU regions. Adjusted diluted EPS excluding currency grew by 9.2% to $1.54. June year-to-date adjusted diluted EPS grew by 15.8% excluding currency. This growth benefited from a gain in Korea related to inventories built ahead of the excise tax increase effective January 2015. As announced in our earnings release this morning, we are reaffirming our 2015 reported diluted EPS guidance at prevailing exchange rates to be in a range of $4.32 to $4.42. Our guidance includes a full year unfavorable currency impact of approximately $1.15 per share at prevailing exchange rates. Excluding currency, our 2015 guidance continues to represent a growth rate of 9% to 11% compared to our adjusted diluted EPS of $5.02 in 2014. Given our better than anticipated volume and market share performance, we now expect to be towards the upper end of this range. As previously communicated, our guidance includes incremental investment during the second half of the year to support the deployment of iQOS in Japan, Italy, and additional 2015 launch markets. Our guidance now also includes accelerated spending in the fourth quarter behind planned iQOS launches in 2016, as well as incremental marketing investment in the second half to further reinforce the favorable momentum of our combustible business. As discussed in today’s press release, our guidance excludes the potential impact of the motion that is currently before the Québec court of appeal related to a judgment involving the two-class actions against our Canadian affiliate Rothmans, Benson & Hedges. Should the court of appeal deny the motion, PMI expects to incur an after-tax charge of approximately $0.09 per share in the second quarter, which would have a corresponding impact on our 2015 reported diluted EPS guidance. Apparently, RBH’s appeal on the merit of the case is pending before the appeal in court. Although the total estimated unfavorable currency impact on our current guidance remains unchanged versus our April guidance, there has been a shift since then in its composition. As you can see on this chart, the positive impact of the euro has been offset notably by the unfavorable impact of the Russian ruble. Strong pricing was the key driver of our financial performance. In the second quarter, we recorded a variance of $540 million reflecting higher pricing across all four regions. We increased retail prices during the quarter in key markets such as Argentina, Germany, Indonesia, and Russia. Our June year-to-date pricing variance of $1.1 billion leaves us well positioned to achieve a full year pricing broadly in line with our historical annual average of approximately $1.8 billion. As a reminder, our first up pricing volumes include the gain in Korea that I discussed earlier. Our results in the quarter were underpinned by continuous market share gains. Share in our top-30 OCI markets grew by 0.1 points to 37.5%, with our share up or essentially flat in 17 of this market. Our share performance was supported by the strength of our leading brand portfolio, which continues to benefit from the rollout of our new commercial approach. The integration of marketing and sales expertise increased consumer focus and field salesforce empowerment is proving to be a competitive advantage. Importantly, Marlboro was a key contributor to our share growth. The brand’s international share, excluding China and the U.S., increased by 0.3 points to 9.5%. This performance was broad-based with share up in all four regions. Marlboro share benefited from the federal rollout of the new 2.0 architecture, which was introduced in some 20 additional markets during the quarter, predominantly in the EEMA region. By year-end, we expect to have rolled out Marlboro 2.0 in approximately 100 markets. I will now provide an update on selected geographies, beginning with the EU region. Cigarette industry volume in the second quarter declined by 3% or 2.3% excluding trade inventory movements. Consequently, we now expect a decline of 3% to 3.5% for the full year versus our previous forecast of approximately 4%. Our new forecast reflects the improving microeconomic conditions and moderation in the level of illicit trade led out switching to fine cut products and the lower prevalence of e-vapor products. The moderation of the level of illicit trade in the quarter is consistent with the findings of an annual study published by KPMG in May. It concluded that the consumption of counterfeit and contraband products declined in 2014 across most EU markets, with France and the UK being notable exceptions. While our cigarette market share for the EU region was stable at 40.4% in the second quarter, our top-three brands, Marlboro, L&M, and Chesterfield all gained share. Marlboro cigarette share was up in four of the top six largest markets by industry volume, with particularly strong growth in Germany and Spain. However, Marlboro share declined in Italy following the brand’s move above the €5 per pack retail price point during the first quarter. Adjusted OCI grew by 4.9% in the quarter excluding currency and acquisitions driven by strong pricing, which more than offset our cigarette volume decline due to a lower total market. Turning now to Russia. The decline in cigarette industry volume accelerated to 4.2% in the quarter resulting in a June year-to-date decrease of 6.5%. We now expect a full year decline towards the lower end of our 8% to 10% forecast range. However, the economic environment remains fragile, and we are witnessing some signs of down-trading to the low-price segment. Our excellent performance in this important market continues in the quarter. We recorded a May quarter-to-date share gain of 0.8 points to reach 27.6%, driven notably by above premium parliament, as well as low price Bond Street and super-low mix, the above which also benefited from wider distribution in the Eastern part of the council. Our cigarette volume grew by 5.3% in the quarter. The combination of the volume increase and higher unit margins driven by significant retail price increases resulted in strong double-digit OCI growth in the quarter excluding currency. I will now cover selected markets in our Asia region beginning with Indonesia. Cigarette industry volume declined by 4.6% in the quarter, following strong first quarter growth of 6%. On a June year-to-date basis, industry volume increased by 0.4%. The shift in adult smokers' preferences from hand rolls to machine-made kretek cigarettes continued in the second quarter with the expansion of the overall machine-made kretek segment driven by the accelerated share growth of full-flavor products. The segment share of lighter-tasting products declined slightly. Our market share increased by 0.5 points to 35.2% despite our relatively high exposure to the declining hand-rolled kretek segment. The share growth was led by Dji Sam Soe Magnum which helped drive a 2.5 point increase in our share of the machine-made full-flavor kretek segment and Sampoerna A, our leading machine-made lighter-tasting kretek brand. During the quarter, we further realigned our production from hand rolls to machine-made kretek cigarettes. While this had an adverse impact on the Asia region's cost in the quarter, it should provide an operational foundation better suited for long-term growth. Over the mid to long-term, we expect cigarette industry volume to increase within a range of 1% to 3% annually driven by the growing adult population and rising income levels. We forecast growth towards the lower end of this range in 2015 due to the recent softening of the economic environment. As announced last month, Sampoerna will explore options to comply with the Indonesian Stock Exchange's mandatory requirement of 7.5% minimum public shareholding by January 30, 2016. This includes potential capital market transactions. In Japan cigarette industry volume increased by 11% in the quarter due to the timing of retail trade inventory movements related to the April 2014 tax-driven price increases. However, industry volume declined by 1.7% excluding this distortion and by 2.6% on a June year-to-date basis consistent with our forecast of a full year decline of 2.5% to 3%. Our market share declined by 1 point in the quarter to 25.4%, so it was down by a more modest 0.4 points after adjusting for inventory movements. We continue to invest behind our brand and for 2015 expect our share to be broadly in line with last year's level. We’re supporting the Marlboro 2.0 architecture which we began rolling out at the end of March and also investing behind our strong pipeline of innovation, as highlighted by the recent launch of the two large variants in the rapidly growing new taste menthol segment. In the Philippines, the competitive environment continues to improve during the quarter benefiting from the introduction of tax terms. Smoking prevalence remained stable in the quarter; however, average daily consumption declined due to higher retail prices. Although it did not deteriorate on a sequential basis compared to the first quarter. This indicates that adult smokers have largely adjusted to higher prices at the bottom of the market. While our market share declined due to higher estimated duty paid volume by our principal local competitor, Marlboro's share increased by 2.1 points to 20.2%. The brand benefited from improved price cost which helped drive the volume increase of 18.1%. As a result of the improved competitive environment and the excellent performance of Marlboro, we’re increasingly optimistic about the OCI outlook for the Philippines and are expecting strong growth this year excluding currency. Turning now to our RRP portfolio, we will commence the national expansion of iQOS in Japan this September. Building on the success of our pilot launch in Nagoya, iQOS will roll out in few regions at the price of ¥9,980 or approximately $80. The rollout will feature an upgraded version of our iQOS in new colors and textures to broaden its appeal among adult smokers. Our expansion plan for Italy also remains on-track with additional city launches commencing later this year. I am also extremely pleased to announce the launch of iQOS in Switzerland this August. The launch will focus on five major cities with retail distribution in approximately 250 outlets by the end of October. The iQOS kit will feature the upgraded version of iQOS while the Marlboro HeatSticks will be available in regular, smooth, and menthol variants. On our e-commerce platform, the kit will have a retail price of CHF 80 or approximately $85 and HeatSticks will return with a premium positioning at CHF 8 per pack of 20. We generated free cash flow of $2.9 billion in the first half of the year. This was in line with our free cash flow for the first half of 2014 despite an adverse currency impact of $1.6 billion. Our resilient cash flow performance was supported by prudent cash flow management particularly with regard to working capital and capital expenditures. For 2015, we forecast free cash flow to be broadly in line with last year’s level despite the significant currency headwind. In conclusion, our excellent start to the year was reinforced in the second quarter with a modest organic cigarette volume decline and a strong currency-neutral financial result driven by robust business fundamentals. In the combustible business, our superior brand portfolio supported by a superb commercial organization is driving strong pricing and continued market share gains. Meanwhile, our iQOS pilot launches are performing well. We’re on track with further rollouts in Japan and Italy and will soon be launching the product in Switzerland. We remain committed to returning 100% of our free cash flow to shareholders. As of last Friday’s market close, our dividend yield of 4.9% was significantly above that of our tobacco peer growth and a 10-year U.S. treasury notes. On a currency-neutral basis, our 2015 EPS guidance reflects the growth rate of 9% to 11% versus 2014 adjusted diluted EPS of $5.02. Given our better than anticipated performance, we now expect to be toward the upper-end of this range. Thank you. And now we’ll be happy to answer your questions.

So first I guess if we think about your guidance for the full year you're thinking the FX neutral earnings growth is coming in at the upper-end of the range. Obviously the first half has been pretty strong. So it sounds like maybe there is some incremental spending that you kind of called out around the iQOS as well as the combustibles. So, is there a way to kind of quantify some of that incremental spending beyond what you had anticipated at the beginning of the year? And then what is sort of prompting some of that incremental spending both on the iQOS side and then on the combustible side?

Look Judy, as I mentioned earlier, we are increasing spending by expediting some 2016 iQOS launches at the start of the year, and we need to enhance our infrastructure and prepare for this year. While we are boosting our investment in the combustible business, we have seen significant momentum and market share growth for Marlboro and other international brands. Therefore, we believe this is the ideal time to further enhance the performance of this brand. To be honest, we are already starting to focus on 2016. We expect a very strong year ahead, but we need to keep that momentum going forward. I apologize, but I won’t specify how much the next investment will be, but it will clearly exceed our guidance without this additional spending.

And then just in the second quarter the margins in Asia came in a little bit softer and I think underlying FX neutral earnings or operating income growth was down a little bit which I guess it’s a little bit surprising given the strong volume performance that you had in Japan. So I know you cited the Indonesia distribution expenses. Can you just talk about kind of the puts and takes in terms of the second quarter Asia margins? And is the Indonesia cost increases sort of one-time for the quarter or is this sort of a continuation into the next few quarters?

In Indonesia, we incurred additional expenses in the second quarter related to reallocating capacity between our hand-rolled and machine-made facilities. This is largely a one-time expense, but it does impact profit margins and overall profitability across the Asia region. For the full year, Asia is expected to perform significantly better than last year, although last year’s performance was quite poor. Asia is making progress towards achieving its long-term growth targets; it might fall slightly short, but overall, prospects for Asia look positive as we move forward.

And then my last question, just on the Sampoerna decision that I guess you’re looking at in terms of some of the capital market transactions potentially. Can you just help us how you’re thinking about some of that decision? And to the extent that there is additional cash flow that comes in with that transaction, would you think about that giving it some cushion to raise the dividends and start resuming the share buyback?

First, we need to decide which new opportunities we want to pursue in Indonesia. I want to put a hold on the question about how a distributor will proceed with the transaction once it happens. The requirements include needing a public flow of over 7.5%, and we are currently below that. Additionally, we have increasing outflows that may not be the most effective. We will need to make our decision while considering these two factors. However, we will need some time to determine the best option for the company and its shareholders.

My first question has to do with your outlook on pricing. It clearly has been incredibly robust in the first half of the year and you noted the benefit of Korea. But as I look to the back half, given how much pricing you’ve already realized. Are there any other callouts in terms of you guys ending up realizing pricing roughly in line with your historical average because right now it would look like you would be tracking ahead of that?

We might come slightly above the historical average; therefore, the language which we use is it will be broadly in line so don’t haunt by $20 million or $30 million. But I think we are looking into the strong pricing for this year but overall pricing environment with the tax and the volumes total industry volume I think are playing on our side. So yes, we’re looking for strong pricing for this year.

The second question has to do with Russia while it’s encouraging to hear that you think volumes will come in at kind of the better end of the range is offset being the down-trading. It feels to me like the down-trading has been at play for a while given the outsized volume gains that you’ve seen for your lower priced brands. So could you elaborate on that comment a little bit? Are you seeing down-trading accelerating? Is that coincident with the second price increase having hit? Any other color I think would be helpful?

I think that’s not until the Q1 I remember the same questions would be asked at that time I said that we don’t really observe much of down-trading growth or down-trading at all in Russia. I mean as we are currently into Q2, yes there was a price increase which was hitting the market in between. I mean yes, you could see that the market somehow consolidates in the middle. I mean the super low price segments are losing, the low price is gaining, the premium is slightly losing. So yes, you have down-trading. And we’ve always had Russia on the watch out list due to the underlying macros and the overall sentiment, etc. Good news is that the Russian volumes, I mean it seems that we are confronted with a bit better elasticities that we price elasticities, which we initially assumed. Hence our revision that more likely or most likely Russia will end the year with about 8% or closer to 8% industry volume decline versus the initial range of 8% to 10%. The volumes for the year-to-date are pretty strong taking into consideration overall market situations and the pricing taken. So yes, I mean a down-trading is where we start seeing. Now, it’s not really a big surprise because Russia operates with a comfort and a matured market with a pretty wide price drops. And the gap between a premium and the low price cigarettes is much higher than what you for example seen in the Western or in the European Union. So yes, there is some room for the consumers to at least temporarily mitigate some of the micro headwinds by hopefully temporary going to the lower price segment. But remember Russia is one of the markets when you see the down-trading if micro is a bit of reoccur situations improve we could see the up-trading. Good news for us is that I think portfolio-wise and I think this was supported by the performance of our two or three brands but bumps through next to the bottom of the market and premium model parliament or a cost premium parliament which all three brands are gaining share. So portfolio-wise we’re okay, we still have to continue watching how Russia unfolds in terms of dynamics between the price segments.

I just had two questions first within EEMA results were obviously still quite good on an overall basis given all the volatility in the region, but I’ve noticed the price mix in OCI growth for both but it’s below trend. Typically we’ve seen them growing at a double-digit rate. So what factors could you call out that have contributed to the more moderate rate of growth in the quarter?

Well, I think the pricing was coming stronger than planned. I think you will slightly presumably would have an impact of some sort of a mix, I mean partially driven by Russia, okay, so this is what it is but overall I think EEMA and Russia in particular we are expecting very strong performance this year for the full year both Russia and the EEMA. I mean a few other locations, the upper geographies in EEMA which have a strong performance, North Africa, I mean a few others. So I think we feel positive on the outlook for this year for instance.

And second question just on iQOS in Switzerland. Can you talk a little bit more about the determination of the price point for the HeatSticks themselves? And just at a broader level, what have your leanings been from Italy and Japan on relative price points? How does the retail price weighed francs compared to comparable pack of Marlboro cigarettes? Do we have any clarity on the tax treatment?

Marlboro HeatStick for the pack of 20 is slightly below the Marlboro. I think that it's 8 francs 50. We decided to go in this market with Marlboro with 8, we have had a tax ratification, and as in Japan, in Italy, iQOS HeatSticks are not classified as a cigarette product and hence will enjoy the lower taxation than the combustible cigarettes.

I guess I was hoping you could drill down a little more on our Marlboro Architecture since you have seen such positive impacts from Marlboro 2.0 in several markets. And then could you give us an idea which particular markets do you feel there could be even more upside potential?

Look, it’s rolling as we speak as Marlboro 2.0 in the additional market as I said. By year-end we should see the mark of about 100 markets so that essentially must cover most of our important geographies. And as well we see and I think if you look at the performance of Marlboro in Germany, I think it's clearly is an impact of a Marlboro 2.0. I think I would say that performance in Germany actually goes above our expectations. And if I look at the demographics how we manage to change the demographic behind Marlboro, so it’s not just the market share current but also how the demographic if goes well from the future of Marlboro. I mean Germany would be one of the markets that we can see the further upside. But in general in essentially all geographies, Marlboro the new support, I mean all sorts of connected with the commercial approach, etc., I mean the year the result.

And that’s a good point and you mentioned Germany because clearly it's done very well, so how realistic do you think it would be to assume the performance that you have seen there could be replicated in some of the other key markets?

It is being replicated, though perhaps not to the same extent as in Germany. Overall, when I consider the changing demographics behind Marlboro's market share, particularly in LA, the brand resonates strongly as a dynamic and innovative choice. The qualitative assessment of Marlboro is significantly better across nearly all markets where we launch the brand. I can’t recall a market that hasn't been a significant one. Our market share performance varies from place to place and can be influenced by pricing situations. For instance, in Mexico, there is some down-trading in the market and pricing pressures at the lower end, which could temporarily erode the brand's share. However, our main focus is on enhancing the underlying demographics for the brands, as this will support growth once pricing is stabilized. Even in markets where Marlboro faces some share pressure in the premium segment, it is still performing strongly and gaining share.

And then Jacek, you guys announced the extension of your strategic framework with Altria Group. So what do you think the biggest benefit will be? For instance, could it be the acceleration of the pace that you are bringing new products to market and/or increasing the number of new products? And then maybe could you give us an idea of how much your investment is behind reduced risk products broadly could increase as a result of this extended framework?

Because as of existing, as you remember agreement with Altria on the current generation of a cigarette product, and this agreement essentially will focus both companies will take them both companies focus behind the new generation of a cigarette focus. I think Altria is bringing to the face of the table quite a knowledge on the existing products and other critical components, I mean there we have our own research, our own discoveries, our own fruits of the investments through R&D. And I think it makes a good sense for both companies from the resource management perspective to pool the resources together and they work for jointly on the new generation. I think logically this should result in an acceleration of the development of a new generation cigarettes product and obviously in both companies could be in their respective markets faster in addressing the consumer needs. I wouldn’t you will appreciate I wouldn’t say how much in terms of a financial investment is required for obvious reasons.

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

Look, if we are looking into sort of a sustainable share buyback program, where we have to go back to what took us out of the share buyback program was currency, and that’s clearly the, there’s a big headwind which we get from the currency and we have made it very clear that in underlying business performance, whether you look at the top-line, bottom-line, etc., and the cash flow generation, it’s coming very ceased, very strong, I mean the currency is essentially sending our credit metrics at the edge of our current credit rating. And therefore, we had to suspend it. So it’s the currency which is the main culprit behind the absence of the share buyback program this year. So we have to see the improvement on the currency front from this side.

And then just on iQOS, you’ve completed some clinical studies recently. On the national rollouts in Japan, and Italy and then also in the launch in Switzerland, is there any health claim associated with those that you are making on the product?

Not a health claim, but I think we are moving slowly into making the reduced exposure claims and this is also the result of the six short-term clinical studies which have been completed as per plan. The study results, they showed a substantial reduction in relevant bio-micros of exposure in adult consumers who switched to iQOS. And this is compared obviously to adult consumers who continued to smoke conventional cigarettes. We have the result of the studies and I believe part of our communications in these locations and other locations which we have not disclosed yet will have a component of the reduced exposure claim.

So just to clarify may be my word choice was a little off; you’re making a reduced-risk or reduced exposure claim associated with it?

But they are two different things, reduced-risk and the reduced exposure. There’s reduced exposure. Based on the knowledge which we have today, based on the results of the clinical studies etc., I think we are getting into positions that we can make a reduced exposure claim. Reduce risk claim is, I think it’s more of the story of the 2016 and depends on the regulatory framework in the countries in which we will be launching iQOS.

And then just on Australia. Could you give an update on what the pricing environment is looking like there, and if pricing from the latest round is sticking, or if there’s any more promotional intensity and I guess specifically to, in the last quarter’s call you said it was looking like less of a drag if even maybe a drag at all this year. Is that still your view or could you give any update on how you are thinking about that market?

I mean we had the pricing in Q2, I mean it somehow sticks, not maybe the talk about the perfections you would like to see but maybe life is not perfect, so we have to live with what we have. As clearly Australia is much less if at all the drag this year and that it used for us last year and I think that’s also the outlook for the full year. We’ll have now the August-September tax price, hopefully price change as well. And we’ll see who this unfolds. You have somehow the downtrading in the market. It’s a little bit slightly better, but I mean it’s not really something which I think at this stage would put us into a jeopardy in terms of our total PMI performance for the full year. But it’s vastly better than last year. But we would like to grow the profitability in this market rather than just the comp basis being better than the last year.

And just one quick last one, in the Philippines, have you seen any impact from the launch of Chesterfield and L&M, is that becoming a meaningful part of that portfolio or is it still early?

Well, it is still early. I think the early results are good, but that’s a bit of the longer runway clearly building a portfolio to reflect the current market reality dynamics etc. And if I can just extrapolate, and I think I have a good reason to extrapolate, of a Chesterfield from other international markets in which we activate, that brand should do properly its designed job in the Philippines market as well. But it’s too early at this stage to start looking. Sales Marlboro, what is very important growth, very strong either share and the volumes, and that’s great because this is what, it’s a good reflection of the trend of the Marlboro and obviously reaction to the lower price is up. Fortune is not doing that bad, it is quite a lot of initiatives about our second brand, which we have the fortune, and I think this brand also has a great future going forward. And I think Chesterfield and L&M are the brands which will maybe initially complement the portfolio and maybe one day they are going to play a more significant role in the overall portfolio.

I just had two questions for you if I could. It will follow on to one of Michael’s questions there. In relation to there is a comment about returning 100% of cash flow to investors. So I am just curious you’ve had some pretty strong operating cash flow performance this year, and some working capital improvements. Is it a two times of EBITDA target you’re targeting here and therefore incremental cash flow if there is better working capital control is that just going towards debt reduction in the short run like we saw this quarter?

No, I mean with the credit rating which we should get it is about 2.5 right, because this is what is allowed for our credit rating if the cash if we deliver the cash flow for this year broadly with line with the last year, last year was about 6.5, slightly above the $6.5 billion, that’s the nice cushion to have versus the dividend commitment which currently stands at about $6.1 billion to $6.2 billion, so this is how we’re looking at the thing we want to have a nice cushion about a current historical dividend at the current level.

One other question if I could please on the facility to make your reduced-risk products to Italy. Is that completed in the third quarter, is that going to be like fully operational? And then should we expect around Q3 to hear about more markets in which you’re going to begin launching that product?

I think the structure etc. are completed or about to be completed and we’re now moving to the installations and equipment to the machinery, so I think it all goes as per plan. As we said, the capacity from that unit, in addition to the training center which is producing the initial 5 billion capacity should be available as of 2016, so very shortly we should have access to the incremental capacity coming from this effort.

Just first I was wondering if you could just expand a little bit on the decision to dissolve the JV with Swedish Match. And looking at that, I would imagine that overtime your emphasis around that portfolio is nascent and smokers would come down, is that an ability to rotate some of those resources back towards your existing business?

Well, I mean the decision, the mutual decision about dissolving the joint venture with Swedish Match was based on the fact that yes, there is some potential for some product in some geographies as we made the progress. But I guess by standards, or our standards the progress was slow, so we just decided that maybe it’s better that both companies will just pursue the on growth opportunities and this is how we reached the decision of dissolving. Swedish Match, sorry the joint venture with Swedish Match didn’t have a material impact on our financials, so I wouldn’t count on any material reallocation of resources from Swedish Match joint venture to PMI.

And then just also kind of more of a housekeeping item, you laid out pretty detailed foreign currency impact in each of the individual currencies in the past, you’ve talked a little bit about hedging particularly on the yen from a transaction perspective. I was curious if you could give us an update on any currencies that you were hedged on like the yen and at what levels and for what duration?

We currently have a hedge ratio slightly above 60% for this year. I want to remind everyone that our financial policies involve looking 12 to 18 months ahead. Therefore, it’s fair to say that we have already begun hedging our cash flows against the yen for 2016. In February, we will provide guidance for 2016 and update our current hedge ratio at that time. As mentioned, we are already planning for 2016, and this is crucial.

I had a couple of questions, my first one was just a follow-up on the snooze question, just interested in whether we should read anything into Philip Morris’ philosophy towards these. Do you see it as part of the reduced risk complex and therefore well worth exploring in a number of places or is it more do you see it as a niche for a few select markets? How are you thinking about that product at the moment?

I think from a reduced-to-reduced perspective, I mean as most theories has a potential from a consumer acceptance perspective based on our experience in a few geographies when the joint venture has launched the products and then commercialized the product, that is things that this is with the longer shot that we were thinking, okay this is how I would look at this.

And my second question was about Poland. I think volumes are down on the market level about 5%, which might not sound that great, but I think it’s the least bad read you have had there for a while. And I just wondered if there is anything changing there for the better and if you could just generally describe the dynamics, that would be useful.

No, Poland is one of the countries which we should still observe like in many other European Union geographies. But there are improved situations with regards to illicit trade that’s in Poland between East and the West, so it always is more difficult to maybe keep these things under control there, but I know that the government is focused on addressing the illicit trade that also addresses the budgetary needs. Our volumes, you rightly noticed, is getting better, but compared to many other markets in the European Union I still would like to see the Polish volumes, total market volumes getting better. Our share is great; I mean our brands are performing great, so on a business side we are in, I think, great shape in Poland total. Our market still I think has room to improve, but we’ll have to see when it's going to happen.

And just one last question on iQOS, how is the retention rate of consumers who try iQOS progressing in Japan and Italy? And also just as a very small technical point, did I hear you right that Marlboro cigarette priced to 8.50 in Switzerland and the HeatSticks are just below that or did I get that the wrong way around?

Yes, that's correct. The pricing is slightly below Marlboro in Switzerland. Regarding the retention rate, it remains largely the same as in Q1; however, we have spent more of Q2 in a test market to modify certain components of our marketing in preparation for the national rollout. As I mentioned in Q1, approximately one-third of those who have purchased an iQOS device are actively using it, but there has been a notable decrease in the number of consumers who are trying to transition.

Your comment with respect to the contributions to European volume is interesting and is there a way you could break apart for us the contributions of the reduction in illicit and in e-vapor? So in aggregate, are those worth about 1% to European Union volumes or is there pricing offsetting some of that benefit so the reduction in those is actually a bit greater?

There is a pricing situation in Europe that is higher than what we had in the first half of last year, which is affecting our volume. However, the underlying market conditions in many European countries suggest that consumer sentiment is positively influencing our elasticities, reminiscent of the 2012-2013 period. Estimating the exact impact of illicit trade varies from market to market. The contribution from illicit trade in Germany is likely higher, while in other regions, it may be different. E-vapor products haven’t significantly impacted Germany, as this category is not substantial there, but they are playing a more supportive role in France, Spain, and other areas. Additionally, we have noted a significant slowdown in the fine cut tobacco product dynamics, a trend influenced by pricing and improved consumer sentiment. This category had previously seen growth rates of around 6% to 7% per year during 2012-2013, but is now experiencing growth of approximately 1%. This illustrates a substantial shift in dynamics that previously drove consumers from manufactured cigarettes to fine cut products more effectively than we see today. I cannot specify how much each of these factors contributes to the overall EU totals; we need to analyze each market separately to understand the varying influences on total market performance. Nonetheless, let's appreciate the overall positive market performance. We recognize what the driving factors are, and we expect that the significant challenges we faced will eventually turn into advantages, fostering a more sustainable trend moving forward.

And then also related to the European vapor markets, does the imposition of the tobacco products directive does that also then create a bit of a headwind for that particular market? And is it really something that probably vantages the Marlboro iQOS and HeatStick system given that you are already able to bring the product to already have a set regulatory environment where is the TPD in position will arguably make things more difficult for vapor? Is that something that you could expand on please?

Well, I mean as everything depends obviously how quickly this going to be transposed into the member state legislation and that’s the process which started. There are some member states which already advanced; there are some member states which give before the parliamentary, etc. discussion. I mean the deadline as we know is May 2016. We will be in a position to say how individual members think what sort of a framework they create above the novel tobacco product and the e-cigarette. As you remember in a TPD there was a distinction between both categories, then we will see how that’s going to play out.

And then lastly on the TPD, which is set to Philip Morris’ litigation against it. Can you give us an update on where things stand and when we may next get the next set of news fill on that? What the progress is in terms of challenging TPD2?

Well, it’s not much really of development which happened, right? I mean the JC case in Ireland was retained in Ireland, which I think is a good news because it drove the other result in a clash of two similarly like cases at the ECJ level. I think it’s fair to assume that the ECJ - sorry, will reach a conclusion before the due date for the transpose implementation of the directive which I said the deadline is May 2016. That’s essential.

And just a couple of questions please. Firstly, just on LatAm and over then the pricing leverage. And I am just wondering what was driving the very strong margins there and how sustainable these are into the rest of the year? And then secondly just on some industry volumes. And could you give an update on guidance for South Korea for the year now? And also possibly if you could comment on how industry volumes are trending in Australia, especially with the recent price increases? Thank you.

So on LAC, I think we have had a strong pricing coming from Argentina, Brazil, Mexico, Canada. So essentially for all our key geographies there we enjoyed the strong pricing. I think it should continue. So I mean LAC last year and this year they are really performing very strongly, I think they had a good momentum. As I mentioned earlier, answering other questions, I mean there is a bit of a share pressure in Mexico. But on the other hand, Mexican total industry volumes are doing better. So overall, into the financials we are looking pretty okay. On South Korea, I mean it looks that our initial guidance for the market, total market for the year 20%-25% decline is not lower to the closer to the 20%. I mean it’s still significant but let's remember, you would remember how big the price increase was. Cutting overall is going better, or slightly better than expected in our share is up. So I think yes, I mean we have the price increase behind us. I mean let’s see how this is going to unfold. But so far it unfolds pretty strongly. And on Australia, not much really as I mentioned earlier which was, which would happen there. I mean if the prices went up there is some continue some sort of discounting. The down-trading is there may be to some extent at the lower level. Australian total market volume is obviously distorted year-on-year due to the price changes. And I think on the year-to-date basis, Australia is 0.7 actually up total market size. But it doesn’t mean that the market grows. I think it’s a little bit of a distortion there.

Most of my questions have been asked. So it’s really a question following up a couple that have already been asked in terms of the question on EEMA pricing. You said that and it was certainly below, the pricing was below my expectations, I didn’t reply to that, you said whether that’ll be some mix factor. But obviously you get pricing per se excluding mix and I was just wondering if for any geographies and you had good pricing in Russia we know. So over any geographies where pricing perhaps has gone backwards or has been disappointing within EU?

Not really. And just one thing to clarify, always when we talk about the pricing is the pricing variance, and when we report the volume mix, we put the mix with the volume the… Yes, but yes, I mean there was some negative mix for EEMA and I think largely driven by Russia. On the other hand, very encouraging and I haven’t seen this result for the long time. We have zero mix impact in EU, okay. So I mean that’s on the total PMI basis, I mean the mix is not that much of a major issue. Obviously we had a mix in Australia due to the down-trading, but is on a few isolated geographies.

Okay, so that’s very clear. And just coming on to EU obviously the volume decline has returned to its historical or nearly to its historic average. I was just wondering if you think elasticity is about where it was before or whether we have some ways to go before we return to what it used to be.

I think many markets have returned to what we would call the standout part of the cover called product elasticity is minus 0.3, minus 0.5, and I see more and more markets which are squarely fitting into this range, even maybe some of that mean in the lower end of this range so in minus 0.3 territory, so that's good.

And just one final question following up a question Bonnie asked clearly your market share is improving and a lot of that has to do with 2.0 but there is also the new commercial approach. And I was wondering really two questions related to that. Is it possible to say at all which is more important than the new brand architecture or the new commercial approach? It is obviously a bit of both, but are they equally important? And the second question related to that is, are there any important geographies where you haven’t rolled out the new commercial approach yet?

I will start with the second one. Important geographies in which we are in the middle of the rollout of the commercial approach is Indonesia from the last OCI market. Coming to how much you could lump with attribute to the commercial approach and how much the 2.0 output like that, Marlboro 2.0 is the concept, it’s a great concept, it’s a great design, it’s a great product line up, it’s a great support materials, and at the end of the day you need to have advanced skills organizations to properly implement this in a market so that’s your commercial approach. So this comes both together, I mean it’s a great idea lousy implementations, no result you have idea, great salesforce, I mean who cares no impact so I think it needs to have always the optimum, the right mix of more than I get we are at this stage now.

And just apart from Indonesia are there any other markets you’d point to that perhaps don’t currently have big OCI contributions but perhaps you could hope to gain share and that you haven’t rolled it out and this would be my final question.

From a significant market perspective, Indonesia comes to mind. In many other markets, we are well advanced, though there may be some territories where we are not fully present. However, we do not aim to cover 100% of any given market territory; it needs to make economic sense supported by a cost-benefit analysis. I believe Indonesia will remain a focus as we move forward.

That concludes our call today. Thank you for joining us. If you have any follow-up questions, please contact the Investor Relations team, and we are currently in Switzerland today. Thank you again and have a wonderful day.