Philip Morris International Inc (PM) — Q3 2017 Transcript

Welcome, and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2017 third quarter results. You may access the release on www.pmi.com, or the PMI Investor Relations app. During our call today, please note the following unless otherwise stated. First, we’ll be talking about results for the third quarter of 2017 and comparing them to the same period in 2016. Second, all references to total industry, PMI volume, and PMI market share performance reflect cigarettes and PMI’s heated tobacco units for those markets that have commercial sales of IQOS. A glossary of terms, adjustments, and other calculations, as well as reconciliations to the most directly comparable U.S. GAAP measures, are at the end of today’s webcast slides, which are posted on our website. Reduced-Risk Products or RRPs is the term we use to refer to products that present, are likely to present, or have the potential to present less risk of harm to smokers who switch to these products versus continued smoking. Today’s remarks contain forward-looking statements and projections of future results, and I direct your attention to the forward-looking and cautionary statements disclosure in today’s presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. Now, it’s my pleasure to introduce Jacek Olczak, our Chief Financial Officer for the last time on our quarterly earnings calls. As I’m sure most of you know, he will be assuming the duties of Chief Operating Officer on January 1, 2018. Jacek?

Thank you, Nick and welcome ladies and gentlemen. We’re pleased by our third quarter performance, notably reflecting very strong currency and financial results, including growth in adjusted diluted EPS of 11.2%; sequential improvement in our total shipment volume performance supported by both cigarettes and heated tobacco units; higher total international market, excluding China and the U.S., and the continued positive momentum for IQOS in all geographies, particularly Japan and Korea. However, industry-wide dynamics in Saudi Arabia and Russia that we have flagged previously are putting pressure on our results and moderating our growth outlook for the year. In Saudi Arabia, the significant excise tax increase in June, which resulted in the doubling of retail prices, is currently driving higher than anticipated declines in cigarette industry volume, especially in the highly profitable premium segment where Marlboro is the leading brand. In Russia, cigarette industry volume is also softer than expected, while net pricing in the market remains constrained by the competitive environment. We are therefore revising our 2017 reported diluted EPS guidance to a range of $4.75 to $4.80 at prevailing exchange rates. Our guidance also now includes approximately $0.17 of unfavorable currency compared to $0.14 previously due principally to the Egyptian pound. Excluding currency and the favorable $0.04 tax item recorded in the first quarter, our guidance represents a growth rate of approximately 9% to 10% compared to our adjusted diluted EPS of $4.48 in 2016. Our full year outlook continues to reflect a total shipment volume decline of around 3% at the low end of the 3% to 4% decline range that we expected earlier this year, as well as currency neutral net revenue growth of over 7%. We do however anticipate a moderate decline in our full year adjusted OCI margin, excluding currency. This primarily reflects the impact of the industry dynamics in Saudi Arabia and Russia, coupled with high investments supporting the commercialization of IQOS consistent with our last duration for a smoke-free future. Additionally, for the fourth quarter, we estimate a positive currency variance on our reported diluted EPS at prevailing exchange rates. This is due to a favorable comparison related to the Egyptian pound, which had an adverse transactional currency impact on our results in the fourth quarter of 2016 due to its significant devaluation versus the U.S. dollar. Let me now take you through our third quarter results in greater detail, beginning with our total shipment volume, which declined by 0.5%, 1.3% excluding inventory movements. The sequential improvement in our total volume decline notably reflected heated tobacco volume growth driven by Japan and Korea, as well as cigarette volume growth in Indonesia and Pakistan coupled with a deceleration in the cigarette volume decline in the Philippines, one of our largest cigarette shipment volume markets. We expect total volume growth in the fourth quarter driven by heated tobacco units despite the anticipated cigarette volume decline in Saudi Arabia where industry volume declined by over 30% in the third quarter and should remain weak into 2018, as well as other Gulf Cooperation Council markets which are expected to implement a tax structure similar to that of Saudi Arabia. We recorded very strong currency neutral financial results in the quarter, building up on our sequential quarterly momentum in the first half of this year. Net revenues increased by 9%, driven by higher heated tobacco unit and IQOS device sales, notably in Japan as well as favorable pricing of our combustible tobacco portfolio. Adjusted OCI increased by 6.8%, primarily reflecting the impact of higher net revenues, partly offset by the increased investments supporting the commercialization of IQOS, particularly in the new region. Adjusted diluted EPS increased by 11.2%, supporting year-to-date September growth of 7.1%. Please note that our third quarter financial results on a reported basis were impacted by the Egyptian pound, which depreciated by approximately 50% versus the U.S. dollar since the third quarter of 2016, based on average quarterly rate and contributed approximately $0.08 of the total $0.12 negative currency impact in our EPS. Thanks for the exceptional performance of IQOS, our third quarter net revenues for RRPs reached $947 million and accounted for nearly 30% of our total net revenues. Please keep in mind that the portion of this net revenues are from IQOS devices, which yield a negative margin due to the introductory discount offered in the initial commercialization phase to accelerate adult smoker switching. While we remain in the early stages of our transformation to a smoke-free future, the size of our RRP net revenues confirms the exciting progress that we are already making on this journey. Our pricing variance of $309 million in the quarter reflects positive contributions from all four regions and was driven by Asia and Latin America & Canada, in particular. Our September year-to-date pricing variance of $1.1 billion came despite essentially no net pricing in Russia. Turning to market share. We recorded a second straight quarter of strong sequential growth in our total international share, excluding China and the U.S., driven by both our cigarette and heated tobacco brands. Our international market share was also up slightly versus the third quarter of 2016. I will now discuss a few of our key geographies, beginning with the EU Region. Total industry volume in the third quarter declined by 4.5%, in part due to estimated 2016 trade inventory movements related to the Tobacco Products Directive, mainly in Italy, France, and the U.K. September year-to-date industry volume declined by 2.7%, consistent with our full year decline forecast of 2% to 3%. Our regional market share, including cigarettes and heated tobacco units, was essentially flat in the quarter. Share in Germany and Spain remained under some pressure, largely due to Marlboro’s move above round price points, which I have discussed in prior quarters. However, France and Poland recorded strong market share gains, driven by Marlboro and Chesterfield, respectively. Share in Italy increased slightly, driven by the strong growth of HEETS. We have now grown our share sequentially in Italy for three consecutive quarters. Regional adjusted OCI in the quarter declined by 7.6%, excluding currency, primarily reflecting higher investments behind the commercialization of IQOS. We expect a return to currency-neutral adjusted OCI growth in the fourth quarter, driven by higher heated tobacco unit volume and a favorable cigarette industry volume comparison. Moving to Russia. Total industry volume declined by 7.9% in the quarter, due largely to the impact of further excise-tax driven price increases, as well as recent growth in illicit trade. For the full year, we now anticipate a decline of around 7% compared to a range of 5% to 6% previously, mainly reflecting the growth in illicit trade and lower expected trade inventory movements at year end due to a shift in the planned 2018 excise tax increase from January to July. Our August quarter-to-date cigarette share increased by 40 basis points versus the same period last year. The growth was driven notably by Philip Morris, largely reflecting the successful portfolio consolidation of low-price local brands, as well as adult smoker downtrading in the market. Our quarter-to-date share also increased sequentially, growing by 10 basis points versus the second quarter. As noted earlier, net price realization in Russia is a challenge this year due to the ongoing competitive environment. In the Philippines, our profit growth continued in the third quarter, driven primarily by higher pricing. Importantly, price increases at the bottom of the market, albeit delayed, have further narrowed the price gaps of lower priced brands to Marlboro and Fortune. Marlboro, in particular, has benefited from the narrowing price gaps, which contributed to a share increase of 3.5 points for the brand in the quarter. While our total cigarette share declined by 2.4 points, it was up by 1.6 points versus the second quarter, reflecting share gains for both Marlboro and finally Fortune. In Indonesia, cigarette industry volume in the third quarter grew by 6.5%, primarily reflecting a favorable comparison related to inventory movements, mainly associated with the timing of Ramadan. Excluding this movement, industry volume was stable. For the full year, we continue to anticipate a cigarette industry decline of around 3%, due mainly to the soft economic environment and related pressure on consumer spending. Our cigarette market share declined by 60 basis points in the quarter due primarily to Sampoerna U and Sampoerna A, mainly reflecting the impact of price increases partly offset by the strong performance of Dji Sam Soe Magnum Mild. Share for Marlboro increased by 20 basis points, driven by the continued growth of our machine-made kretek Marlboro Filter Black offer, up by 1.7 points, following distribution expansion, partly offset by the decline of Marlboro in the whites segment. This was mainly due to its price increase above the round price point of 20,000 Rupiah per pack. In Japan, the spectacular performance of IQOS continues to drive our results. Our total market share increased by 5.3 points to 33.2% in the third quarter with HeatSticks up by 8.4 points to 11.9%. HeatSticks is currently our largest brand in Japan and the second-largest brand industry-wide. September year-to-date total industry volume decreased by 4.1%, excluding inventory movement, consistent with the secular decline range for cigarettes prior to the introduction of IQOS. Our retail off-take shares in Japan further highlight the success of IQOS, irrespective of geography and the presence of competitive smoke-free products. HeatSticks closed the quarter with a weekly off-take share of 14.6% nationally, up by 1.9 points versus the last week of the second quarter, with share gains across all areas. Importantly, we are beginning to fully supply the Japanese market with HeatSticks and build normal inventory levels commensurate with the growth in demand, a process that we expect to continue in the fourth quarter. As part of this effort, we began the process of shifting our HeatSticks shipments to Japan from air freight to sea freight during the third quarter. However, we effectively remain supply-constrained in the market due to IQOS device capacity. This limitation should gradually ease over the coming months, in part due to the increasing contribution of devices from our second supplier. We expect to be able to fully supply the market with devices in early 2018 based on our current demand forecast. The current constraint on devices also reflects a growing number of consumers who choose to own multiple devices or who upgrade to the latest device model sooner than we had initially assumed. Turning to Korea, the exceptional early performance of IQOS continues. National market share for HEETS reached 2.5% in the quarter, despite a relatively limited distribution focusing on Seoul and other major cities. This success has been driven in large part by high IQOS awareness, which exceeded 50% among adult smokers nationally within just four months of launch. In fact, before IQOS was even launched in Korea, its awareness had reached around 20%. Another measure of the early success of IQOS in Korea is the high level of full and predominant conversion, which reached 83% in September. This is already above the 70% to 80% range generally observed in our more established IQOS launch markets. Looking now at some of our IQOS launch markets in the EU Region, we're approaching and even exceeding, in the case of Greece, a national market share of 1% with solid growth compared to the third quarter of 2016. As our weighted distribution in this market still only ranges from around 35% to 75%, this clearly implies higher shares within the areas where we are focusing our marketing and distribution efforts. Additionally, in all five markets presented on this slide, we increased our sequential market share compared to the second quarter. In EU, EEMA, and Latin America & Canada Region launch markets, where our focus remains more targeted such as those presented on this slide, we’re also pleased with our overall progress. With the exception of Spain where IQOS was only launched in the fourth quarter of 2016, we grew our focus area off-take share by at least 50 basis points in each market over the past year, and also increased our share sequentially compared to the second quarter. It is important to note that the positive momentum for IQOS outside Asia has been achieved despite the more challenging environment for building IQOS awareness and product comprehension among adult smokers, which is due largely to the stricter limitations on consumer communication. Furthermore, adult smokers outside Asia who purchase IQOS generally have similar high levels of product conversion. Turning now to shareholders' returns. In September, our Board approved an increase in our quarterly dividend to an annualized rate of $4.28 per share. This marked the tenth consecutive year in which PMI has increased its dividend, representing a total increase of 132.6% or a compound annual growth rate of 9.8% since PMI became a public company in 2008. Before concluding, let me share a few comments on the management changes and new geographic segmentation, announced on September 28, which are intended to drive the Company's transformation towards a smoke-free future while maintaining its financial performance. These changes should enable faster decision-making and a greater focus on both parts of our business, i.e. combustible and the reduced risk product. Effective January 1, 2018, PMI will operate in six geographic regions, up from the current four, as you can see from the slides presented. A detailed split of the markets by region is included in the glossary of this presentation. We will begin reporting results based on the new regional structure as of the first quarter of 2018 and plan to provide three years of historical data, reflecting the new structure no later than our first-quarter earnings release in April next year. To conclude, we recorded very strong currency-neutral financial results in the quarter, supported by a sequential improvement in our total shipment volume performance. The strong momentum for IQOS continues. To date, we have launched IQOS in key cities in 31 markets and more than 3.7 million adult consumers have already stopped smoking and switched to IQOS. Our revised 2017 EPS guidance reflects a growth rate of approximately 9% to 10%, excluding currency and the favorable tax item compared to adjusted diluted EPS of $4.48 in 2016. This strong full-year outlook reflects currency-neutral net revenue growth above 7%. Finally, we remain focused on generously rewarding our shareholders with our robust cash flow. For the year, we continue to target operating cash flow of approximately $8.5 billion, and a capital expenditure of $1.6 billion. Thank you. And I will be happy now to answer your questions.

And I have a couple of questions, please. First of all, you’ve obviously seen good growth in Japan, but nonetheless slower growth than you saw in Q2. And I’m talking about the market share growing by 190 basis points quarter-on-quarter on the IMS basis versus 290 last quarter. I was wondering if that’s entirely due to the fact that you have supply constraints on the devices, or is it perhaps because now, as you grow, gaining market share is harder, or is it somewhat due to the competition? That would be my first question.

The largest weight on the supply of devices compounds the fact that we observe more and more converted consumers who decided to own more than one device. But that obviously creates additional bottlenecks in those devices, which we shipped instead of going to the new consumers in July. I mean, they go to the existing consumers. Obviously, there is some impact of some competitive products. As you know, they are not nationally available. I’m very pleased that even in the places where they are available, I mean IQOS continues to grow. As I said, our total highest weight is to the device availability rather than our dynamics in the market, but you’re right to say, Adam, that the higher you are, presumably it’s more difficult to grow. But I still would think we have quite the runway to deliver in Japan.

And then turning to Europe. One of the things that strikes me is the big contrasting growth rates between Europe and East Asia. I was wondering if looking forward, there is anything that you can do to accelerate the growth or whether the strategy is to continue to grow market share but at a rate which is much slower than in East Asia?

I mean we wish to grow the market share of IQOS in Europe to the level that we have in Japan and Korea, just the operating environment is different. I mean the market in communication and the channels for the communications, which are available to us in the Asian market, are not necessarily available in Europe. So we are in discussions also with the regulators and we’re doing our efforts because it is mainly based on the one-to-one marketing in July. Obviously, this takes time. If I compare the efforts to which we’re putting in place and the productivity of those efforts in Europe, they’re pretty high. Now, I know that we are particularly excited about IQOS, but I have seen my experience in this company reflect the one thing. All European markets, despite the fact that some people may perceive the growth of IQOS to be lower than I expected in Asia, are well ahead of any comparable product launch in a combustible category. We know that we're pushing the right product in the market. There are no discussions that we will continue with that. I think 2018, as you noticed, Italy after some time is now crossing a one-share of the market. I think that 2018 in many markets in Europe will be a turning point. We just have to continue to stay focused in ways that what we’re seeing is working. Conversion rates from those who we approach who purchase devices are at a very high level. It is just a matter of effort and the results are going to come. There will be a tipping point or turning point in these markets where word of mouth starts playing a much higher role to the extent as we observe in Japan and Korea.

One final question from me. You said you will build inventory further in Q4. Really the question is, when we’re looking at 2018, do you feel you need to build inventory of IQOS any further, or will you be comfortable if it is at the levels you want in East Asia and, I guess, in Europe as well?

We have observed an inventory movement of just over 2 billion in Japan. This includes a decrease in inventories of combustibles due to declining volumes. Adjusting the IQOS inventories to a sustainable level will enable us to continue meeting market demand without issues. This isn't a typical inventory buildup seen before a product launch, and I do not anticipate that the inventory pipeline to Japan will return to normal levels in 2018, corresponding to our expected demand for the product. Unlike traditional business scenarios where inventory movement in one period leads to negative impacts in the next, I do not foresee that happening here.

One or two just start with the combustible business. So arguably the competitive and pricing environment this year has been more challenging in some of your markets, like Russia and Germany. I just wanted to get your color in terms of what you think is different this year, and how you are thinking about whether you need to really shift your strategy there?

On the pricing front, the biggest negative surprise unfortunately came from Russia. The net pricing for that launch this year, along with the net manufacturers’ pricing following January discussions, was unexpected. Given the market size and our position, this significantly impacted our numbers. At the beginning of the year, we anticipated some pricing challenges, but I admit we didn't expect it to lead to a prolonged deadlock. I hoped that things would improve in 2018 as prices were gradually adjusting in Russia, making that year appear better than 2017. However, Russia was the only market where pricing negatively affected us. In Germany and a few other markets, delays in price increases are somewhat expected. While it’s not pleasant, it’s not surprising either; it’s a bit of business as usual. The situation in the GCC, particularly Saudi Arabia, has also been complex, with prices increasing significantly. The industry platform is under pressure due to these price hikes. Many investors may not fully appreciate the scale of the GCC market in terms of both volume and profitability. Saudi Arabia's market was around 32 billion units in 2016, with PMI holding about a 41% share, and Marlboro capturing more than half of that. Our margins exceed the average PMI margins. When the market declines, particularly with a drop over 30%, it exerts substantial pressure on our financials. At the start of the year, we set a guidance of 9% to 12% EPS growth, and I am confident that without the challenges in Saudi Arabia and Russia, we would have exceeded 12%. Given the strong performance of IQOS, if we didn't have to factor in the situations in Saudi Arabia and Russia, we would be achieving much better results.

So then on IQOS, I mean, it seems like you’ve ramped up the investments in the EU pretty significantly year-to-date. I just wanted to get a sense of if IQOS profitability is tracking to breakeven as you indicated before. And then as we think about the expansion plans in the EU, how should we think about the phasing of some of these markets in terms of going to a fuller distribution and the ramp, and what should be expected to see in that market in 2018?

We have said that IQOS will be breakeven in 2017. In fact, in the quarter, IQOS already contributed to the total PMI bottom line. So as we’re actually going to do the better...

Can you quantify how much?

Judy, maybe one day I will, but I did not today. But we said that we breakeven, and we are essentially coming to the breakeven in Q2 about and Q3 confirm that there is a net contributor to the bottom line, which is very handy, if you like, also from a perspective that we have this again Saudi and the Russia events. So despite the two severe adverse situations, we can still deliver, in my opinion, pretty strong results. There is one component when we talk about the investments in our IQOS. There was this component of devices, and we have been saying from the very beginning that if devices, to some extent, inflate, if you like, our revenues, we do not make margins on the devices; quite the opposite. Devices alone are a drag on our margins. If I did the calculation and excluded devices from the last quarter Q3 results, my margin, my OCI margin would be up somewhere in the range of 80 basis points to 90 basis points. What went on one hand is positive because if consumers are buying a second device, it means that we’re really building better loyalty among consumers to stay with IQOS, which is very good also versus the potential competition. But on the margins, it puts a little bit of pressure. As you know, as of mid-year or second quarter of this year, we started to increase the device prices targeting about $110 worldwide; it will take time when the device price will go up in the market. We’re trying to address that, but obviously, devices will not be as accretive to our margins in the bottom line as HeatSticks or combustible products. We have to be careful when we look at the numbers.

And my last question in Korea. So I know there is a post of vote this week on taking the IQOS tax up to 80% or 90% of the combustible. I’m just curious, as you think about other markets and the discussions you’re having on the tax structure. Is the conversation shifting to a recognition of the relative risk difference and so there is some level of tax differential that the governments are pursuing? Or do you think that the current tax rate going up to this 80% or 90% eventually is actually a little bit more disappointing?

We’re always weighing the opinion that the product warrants a different tax treatment than combustible classical cigarettes. So on one hand, yes, I mean in Korea, they are trying to move the tax up. I think they are recognizing that the product should enjoy different taxation than combustibles. We’ll see where we lag. The decision is not final. But my understanding is that the product will have a real benefit from lower taxation compared to combustibles. Remember also is the growing understanding of harm-reducing principles, in which product innovation plays an important role. Even the most recent FDA announcements squarely fit into this direction. I would assume that the tax policies, as many other regulatory policies, will differentiate both categories to the benefit of the reduced-risk products.

So I just wanted to revisit the guidance change, please. I very much appreciate your candor around the pricing development in Russia. It seems you’re going in expectations, as well as the big drags in the GCC. Since February, you’ve opted the 9% to 12% guidance. So it seems to me that perhaps there was another lever that you were hoping would materialize to justify something at the high end. So if you could just comment please on your decision to hold behind the guidance up until now, given that some of these negative factors that you called out were known over the course of the year.

If the pricing environment in Russia were to improve more quickly, we would be within our 9% to 12% guidance, or possibly at 9% to 10%. The situation in Russia, if it were to last for a shorter duration, would have kept us at the higher end of our guidance. I previously mentioned that if the GCC issues in Russia had not occurred this year, we would have been significantly above 12%. I won't put a specific number on it, but it’s more than just a small increase; we would be around 12%, assuming IQOS continues to perform as it has been.

And then my next question, just on pricing more broadly. I fully appreciate the nuance around Russia, given the multi-year half change, which has been quite aggressive. But if I look at your business over the course of '17, with the exception of Latin America, it does look like on the combustibles business, price mix realization has decelerated across the board. This is the harsh I guess from investors a lot in terms of the sustainability of the pricing model. Given that we’re seeing that decelerating price mix across a number of your geographies, I was just wondering if you can comment on the durability of the pricing model, please.

I would add that regarding Russia, there is currently a level of pricing. Our pricing variance remains in what we typically state, around 6% to 6.5%. At this point, we know we are now below 6%. However, we are still seeing strong price realization; Russia is just the area where this is missing. In some countries, the effectiveness of tax structures and pricing can be uncertain, as there is often a trade-off between volume and pricing, as seen in Italy and France, for example. Other than that, we have encountered some delays in pricing in Germany. Frankly, every time we've attempted to implement price increases in Germany over the past few years, we have faced delays. While this situation is not ideal, it is not surprising either. As for Russia, I don't believe anyone has achieved the level of success there that we have, which is a positive sign.

And my last question just on IQOS. Specifically, I'm looking at Germany and the reason I am focused on that market is just pretty much equitable were so good relative to other European markets. It looks like perhaps you lost share on IQOS in Germany, if I'm reading the chart right. You had 60 basis points of share in the third quarter. I believe it was 80 basis points in the second?

No, I don’t believe we lost market share in any of these areas. The only place we've noted growth, albeit modest compared to others, is Spain. In Germany, the numbers for the third quarter were 0.6, while the previous quarter was 0.4. It's important to remember that we don’t have a strong presence across the entire market in Germany; we mainly operate in a few cities. I recently visited Munich, and I think things are beginning to improve gradually. Germany, while capable of producing quickly, tends to move at a slower pace overall. Therefore, I am eager to concentrate more on markets like Germany and others.

If I could revisit the heated tobacco category in Japan, as you've mentioned, there are device constraints and some short-term limitations affecting market share progression, which is still quite strong. Could you share any insights regarding how IQOS interacts with competitive products that are entering the market? It's evident that this competition hasn't hindered your growth, but consumers likely want to try new products. Are you observing significant feedback from consumers using both IQOS and rival products? Are they considering using them together or possibly switching back to IQOS completely? Any context you can provide on this would be appreciated.

Well, there are obviously some interactions from IQOS users with competitive products and vice versa. The feedback we’re receiving is that taste-wise and overall experience and the taste is very important because people using a product want satisfaction and satisfaction is stage. IQOS seems to come very strongly. So at this stage, to be very frank with you, I’m not that much worried about the competitive offerings here. But obviously, there will always be a trial in a new category, and why people should believe one product over the other in the category. There will always be new propositions. But nothing really would disturb me at this stage. As is innovation, we are working also on further improvements of our products, and I guess competitors are exactly focused on the same aspects. So, the game is over. So far, we’re winning and I hope we will continue winning.

Just with respect to share repurchase and the dividend increase you just put into effect, could you just give us an update on how you’re thinking about the potential for repurchases next year? I mean, currency at least on our estimates looks pretty much neutral, and my sense is that you’ve always been hoping that it would swing in a more positive direction before you would feel very comfortable pursuing repurchases. Given good earnings momentum and the fact that it doesn’t appear to be a headwind next year, does that make you more optimistic about the prospect of reinstituting a bit of buyback?

I think our focus will continue to be on the dividend, even at the times when our balance sheet was or is under pressure. We’re still under pressure. We still haven’t recovered where we should be to be in line with our prescribed ratios coming from credit ratings. I don’t think in the near term, we will get back to the buyback unless there is a sudden reversal on the currency. There are currencies that we have to come each time positive to us. I would have to be in the times of a better weak dollar that we would recover fully the desired balance sheet trends and start thinking how to deploy the cash to our shareholders in other forms than just dividends. So, I think our focus will remain on the dividend and reward shareholders for the dividend, hopefully dividend growth.

Okay, I think that’s pretty clear. Thanks.

Thank you.

I was wondering if you could provide more details on the spending for IQOS. Has that increased? I'm specifically interested to know if that's related to the adjustment in your guidance. Given that you've maintained your revenue guidance, does it mean that the upper limit is open-ended? Are you closer to 7% than before? Or, considering the revenue guidance remains the same and you’ve noted weaknesses in Russia and Saudi Arabia, have you found a balance somewhere else that's lower margin? How should we interpret all these factors together?

We expect to achieve around 7% revenue growth, with the higher end of our guidance always reflecting similar revenue figures. The number of devices and HeatSticks we can ship plays a significant role in this. We have a clear understanding now of the volume and pricing expectations in markets like Russia and GCC. Previously, I mentioned that we were reaching a point where 7% revenue growth seems feasible, and I genuinely believe this could become a new standard for PMI. The combination of volume and pricing growth indicates a solid top line growth potential for the company. While we might exceed 7% revenue growth in this quarter, any adjustments I might make would still keep us well above our historical target of 4% to 6%. Our approach at PMI aligns with the idea that this level of top line growth can be maintained, focusing on long-term performance rather than quarterly fluctuations. This is what we aim to achieve.

Regarding the marketing investment for IQOS, is the spending incrementally higher, or do you plan to keep it pretty much the same as before?

Higher than last year. Clearly, we are not increasing beyond what we had already planned for this year. We are simply implementing those plans. There is a variable component, as I mentioned earlier. We have observed that investment should also account for the devices or some loss associated with them. This is a variable factor since consumers may choose to purchase more than one device, which naturally increases investment. However, we are working on our pricing strategies to address this. On the other hand, we are beginning to see the first signs of consumer loyalty, as customers are willing to buy and use multiple devices only if they are confident in their choice within a category. This bodes well for future periods. It indicates that we have satisfied consumers. We are currently rolling out new versions of our devices, and I believe it will become standard for us to introduce additional devices periodically. There is also increasing demand for accessories and personalization options. Japan, in particular, will be at the forefront due to its larger consumer base. We anticipate additional revenue and hopefully margins from the significant opportunities ahead. Therefore, some developments are occurring more rapidly than expected, which may put pressure on multiple device ownership this year with reduced margins. Ultimately, while we are facing some challenges, I believe this is very promising for the next period.

You've mentioned how you've managed to secure enough capacity to stop building inventory in Japan and reduce air freight costs. Do you still anticipate being capacity constrained for the rest of the year? If that's the case, it would imply…

On a fixed basis, we should now, if you remember, we have targeted year end installed capacity of 50 billion, and now with the latest plans and the installations, et cetera, I think we should be above the 60 billion at the end of the year. We’re already lifting the numbers. We’ll update the investors' community in February on the outlook for capacity for the next year. As we’re still locking in some plans, but I think, on the HeatStick side, we start getting comfortable. Device I think as of this quarter, as of last or the fourth quarter, we should also be okay. We activated the second supplier, which offers an even bigger capacity than the first one. I think as of the beginning of next year, assuming our forecast for demand is what we have decided, we should have the first year of normal operations when it comes to the supply side of the equation.

Just one on Indonesia, your competitor JP obviously is making a bigger push there with an acquisition. Does that impact any of your thinking on what some of the competitive risks in that market might be?

I kind of think, you mean Philippines, right or JP?

Well, Indonesia specifically where there is a big part of distributor and…

Okay. But I don’t think that it's going to drastically change the dynamic in Indonesia. In the Philippines, yes, the positive developments are also occurring. So my focus is more on the Philippines than on Japan and Indonesia.

A lot has already been asked and discussed, especially regarding the stepped-up spending behind IQOS. But I guess I wanted to go back to something you mentioned in your prepared remarks in terms of the required higher consumer spend to increase awareness. I'm trying to understand why this might be different in some of the markets you’re pushing deeper in versus some of your more established IQOS markets.

In certain markets, we cannot fully disclose information about IQOS and the benefits compared to combustible cigarettes. Regulations tend to be somewhat reactive, making it challenging to govern products that are already available. While these products are on the market, regulators often decide how to approach them afterward. We're in situations where it isn't clear that we're distinguishing between heated tobacco and combustible products, so we must adapt to local regulatory conditions. We are aware that consumers can switch to IQOS and quickly notice the benefits, experiencing symptoms similar to those who have quit smoking, which is positive. This creates word of mouth among consumers, though it takes time. Additionally, in different markets, we have access to various marketing channels for communication. For instance, in Germany, outdoor advertising is allowed, but we are limited in what we can say due to regulations. Meanwhile, in Italy, we could communicate more but lack outdoor and print options, confining us to specific tobacco-related avenues. Each market presents unique challenges, necessitating adjustments in our strategies and infrastructure to engage with consumers effectively. Ultimately, there will be a consumer tipping point that will generate a snowball effect, similar to our rapid success in Japan and Korea.

And then just a final couple of quick questions on Japan. I guess first, could you update us on how the new HeatStick variations you introduced into the market performing? And do you anticipate more introductions? And then on your combustible business, could you give us an update on the price increase and how you expect that to play out for the remainder of the year in that market? Thanks.

The new menthol flavor has been very well received. We are shipping what we produce. There is some internal competition among our variants, and consumers are shifting from other options. This new variant caters to existing taste preferences found in the combustible market. We will attempt to address an important taste segment preference in some markets, with Japan being a primary focus. Regarding pricing in Japan, we have a history of attempting increases, which led to a rise in Marlboro prices. We expect prices to remain stable for the New Year unless there are changes in taxation. For the first time in a long time, our operations in Japan are generating growth in adjusted operating income, aided by strong volume performance. We are experiencing significant growth in Japan, and any potential pricing changes would be an added benefit. We are well aware of our pricing position in the market, but historically, pricing has been a barrier to market growth. We have now discovered that it is possible to enhance profitability in the market without relying on price increases, which is unusual but is currently happening.

So just a quick question for you. As you think about the number you gave, 60 billion sticks available, HeatSticks available, at the end of the year and that growing through 2018. I just wanted to understand how we should about launches for IQOS in other markets, particularly in Europe where you’ve got a base, if you will, for the product. Related to that, how do we think about platform two and when that might launch or go through the test market?

The platform is likely to begin in the second half of the year and will enter the test market this year, although we have not yet disclosed the specific locations. The capacity is projected to reach approximately 60 billion annualized by year-end. There are no immediate plans to increase capacity for next year, but we already have 60 billion in place. We are in the process of adding new machinery and activating other factories in Italy. We've already made our first shipment from the production facility in Romania, and everything is progressing as planned. We will provide an update on capacity in February. Initially, we aimed for a year-end capacity of 100 billion by 2018, and we will start the year with a greater capacity, suggesting that our year-end installed capacity for 2018 will be correspondingly higher.

So think about from that standpoint with 15 billion sticks of availability in the fourth quarter. Is that sufficient to start a national launch in another market? Obviously, you have Korea building as well here, so it’s larger...

In all of these markets, we always balance where is the right moment to go national. We try to build a larger IQOS communities within a territory. We have places in Italy, in Switzerland, in Germany, where locally if you like markets are 2%, 3%, 4%, 5% depending on the location. But this is how we want to build the whole thing before we start spreading the results across the broader geographies. If you look at the markets also, we started already some developing market, which is also very important in our strategy. I think on the chart we had Colombia, which came to the 1.4% market share in Q3; very strong start. We will be in several geographies, trying to either open the market for the first time, starting with one city, two city capital cities, and in cities where the market has already been presented in some cities to assess which of these markets we think are ready for national expansions, taking into consideration also availability of the marketing channels, et cetera. So how labor and capital intensive this might be for us in the next year. What we have created through 2017 is a very nice base of a market to select from for 2018 expansion plans. So I think this was our objective. Some markets may go full speed in 2018; some will go in 2019. We now have the luxury, if you like, of choosing how we want to push the pedal.

I just wanted to follow up on your total cost for the quarter, which we estimate increased significantly in constant currency. Do you anticipate this trend will continue in the fourth quarter, and will it carry into 2018 as you plan more launches and invest further in IQOS?

There is investment behind IQOS. Remember the total cost; you also have just the impact of IQOS, right. On a purely COGS, due to cost on the COGS, due to cost, the cost will be flat, very marginally different due to COGS. If you take the volume impact, you will have a positive on combustibles because we produce less and you have a negative on IQOS because we produce more. Actually that negative on IQOS offsets the positive on the conventional.

Couple of questions, if I might. First of all, just a very specific one. In the Asia region in Q3 on the conventional business scale, PMI cost, to put the price mix in Q3 seems to be decelerating very sharply. So I can understand even with Russia and then so on so forth. But why is the price mix in Asia for the conventional business decelerated through sharpening at the quarter?

It would be driven by the Philippines on the volume, and Australia on the volume mix; the rest would be on that positive side. I'm just thinking what drove those CI and where were the variances coming from.

Assuming Philippine volume is up; Australia volumes down?

Yes, Australia is presumably also the mix component. Philippines should be on the positive need because Marlboro is nicely growing there, but volumes are lower. I guess in Australia, if I remember, there might be some other smaller markets also there.

If you’re constrained on the device side, does that mean on the HeatSticks side in the third quarter, you could have produced considerably more?

On the HeatSticks side in the third quarter? Not really, because production is still ramping up. If I would take the year-to-date production versus what we have shipped, or sold if you like, I think the delta is literally a couple of billion, I guess. There are somewhere in the pipeline and the factory warehouse, et cetera. So now we’re shipping to, because now we start having some level of inventories in Japan. Japan is not much restricted on the HeatSticks sales. But obviously, we can supply the market with the HeatSticks, but if you don’t generate the new consumers because you have devices, that is becoming the bottleneck. As I said in Q1, I assume when the devices should be in free supply and HeatSticks will have an inventory and will continue to be in a full supply, we should start seeing the first quarter of operations result in constraints on neither the device nor the HeatStick.

And also in discussion with platform two, I mean, the capacity that you’ve talked about the 100 billion or indeed more HeatSticks at the end of this year, $100 billion or more at the end of next year. Does that presumably apply to platform one or IQOS plus platform two? Is that correct? Is that likely to be actually a meaningful number for platform two in ’18 or no?

Well, to some extent, yes because there are two processes in making HeatSticks; one is the tobacco processing, and that process is shared between platform one and platform two. Capacity can be shared when it comes to making the final product, the stick, the HeatSticks and the platform two will have different machinery. So partially, the capacity is within these numbers; partially capacity for the P2E within these numbers. Remember, we’ll go to the test market this year. We’ll learn, start to assume that we may need to modify something and then we’ll start thinking whether the right markets when we start launching the P2. I don’t think that this is that much of an issue for us in 2018; that will obviously have some capacity for 2018, then we’ll have to decide how we want to expand that capacity earmarked only for P2 going into 2019 beyond.

Just to clarify, if the capacity for P2 on the secondary side allows, can you see traditional conventional machines producing the stick on the P2?

No, the machinery line is different. We have always maintained that the concept of combining a few components in the formula route, which is a cigarette or the HeatSticks, remains the same. Therefore, our objective is to maximize what we can achieve within our existing facilities, allowing us to utilize our workforce and leverage our scale. As a result, the learning curve is significantly improving. However, in terms of machinery or capital expenditures, this will necessitate a separate program and investment.

So, P2 picks up. Can we expect another build-out of capacity in different build-out capacity?

Yes, but I think we also have learned how to build the capacity on P1. So once we build the first RRP factories, remember that the quality assurance processes are different than in combustibles, et cetera. It is very likely that P2 will be produced somewhere along P1. So I think there are a lot of investment parts that were made behind P1, will serve P2. But that will require separate dedicated equipment.

And lastly, just in the switch from air freight to sea freight, particularly for IQOS. When it comes out to factories sold, it goes presumably to PNS or whatever it is. At that point, who gets the benefit of the lower costs of sea freight versus air freight? Is that margin benefit to you, or is that the margin benefit to TNS or is it split somewhat?

This is Philip Morris International Inc who take the full benefit of... It's us; it’s just our cost because we cover the air freight. This doesn’t change anything on the revenue recognition because always rolls out the warehouses, et cetera, plus-minus. But this is always at the center of manufacturing. It technically creates, optically creates that higher inventories, which somebody was loading at the beginning of this call today because when I have air freight inventories, how long is the plane flight, is a flight from Italy to Japan. You could assume next day you have a cigarette on the other side. But when I put the cigarettes on the boats on the ships and obviously you count the eight weeks or so of either inventory, revenues recognize, but inventories not as accessible to the market for further commercialization because it’s on the water. This is just a technicality of this thing. We’re trying to put the HeatSticks to the same model or operations models that we have for combustibles. There is a significant difference in shipments and sea shipments; air freight...

Yes. But who gets the benefit of the shifting in terms of...?

Yes, it’s all to us; it’s nothing to whoever distributes or anybody else in a supply chain.

Hi guys. My questions have been asked. Thanks.

Okay, have a good day.

Well, thank you very much. That concludes our call for today. If you have any follow-up questions, please contact the IR team here in Switzerland. Again, thank you again and have a great day.