Philip Morris International Inc (PM) — Q1 2018 Transcript

Welcome and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2018 first quarter results. You may access the release on www.pmi.com or the PMI Investor Relations App. A glossary of terms, including the definition for reduced-risk products, or 'RRPs,' as well as adjustments, other calculations, and reconciliations to the most directly comparable U.S. GAAP measures, are at the end of today's webcast slides, which are posted on our website. As a reminder, effective January 1, 2018, we began managing our business in six reporting segments reflecting a new regional structure. Three years of historical data reflecting the new structure are available on our website and in the Form 8-K that we submitted to the SEC on March 23rd. Please also note that we are now using operating income to evaluate business segment performance and allocate resources, replacing operating companies income, or 'OCI,' which was used prior to January 1, 2018. OCI was defined as operating income, excluding general corporate expenses and the amortization of intangibles, plus equity income or loss in unconsolidated subsidiaries, net. Today's remarks contain forward-looking statements and projections of future results. I direct your attention to the Forward-Looking and Cautionary Statements disclosure in today’s presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. It's now my pleasure to introduce Martin King, our Chief Financial Officer. Martin.

Thank you, Nick, and welcome, ladies and gentlemen. As announced this morning, we are increasing our 2018 reported diluted earnings per share guidance, at prevailing exchange rates, by $0.05 to a range of $5.25 to $5.40. The change reflects a lower estimated full-year effective tax rate of approximately 26%. Our guidance includes $0.16 of favorable currency at prevailing exchange rates. Excluding currency, our guidance represents a growth rate of approximately 8% to 11% compared to our adjusted diluted EPS of $4.72 in 2017. The reduction in our estimated effective tax rate for 2018 to approximately 26%, versus the 28% that we had previously communicated, is driven by two main factors. First, further analysis and interpretation of the Tax Cuts and Jobs Act, primarily related to foreign tax credit limitations due to the Global Intangible Low Taxed Income provisions of the Act; and second, revised foreign income tax estimates due to a change in the mix of our foreign earnings. I must caveat that this estimate reflects our current capital structure, as well as our current interpretation of the new tax law, which may change as further regulations and clarifications become available. It also reflects current assumptions regarding earnings mix and tax rates by taxing jurisdiction, which may also change. Our revised guidance also incorporates some caution related to the evolution over the balance of the year of three elements which I will cover in more detail later in my remarks, namely; the timing of price increases in Russia, although the start of the year has been encouraging; slower-than-initially-projected RRP category growth in Japan during the quarter. Given the phenomenal category evolution, we are now reaching different socio-economic strata with more conservative adult smokers who may have slightly slower patterns of adoption; and the pace of recovery of cigarette industry volume and our market share in the GCC, particularly Saudi Arabia. Consequently, we have not passed through the full benefit of the lower estimated tax rate to our 2018 guidance at this early stage of the year, but we will monitor how these dynamics and our related initiatives progress as the year unfolds. Our revised guidance reflects currency-neutral net revenue growth of around 8%. Turning to our first-quarter results, we recorded strong currency-neutral net revenue growth of 8.3%, driven by higher volume for heated tobacco units and IQOS devices across IQOS markets, coupled with higher pricing for our combustible tobacco portfolio across all regions, notably South and Southeast Asia and Latin America and Canada. Adjusted operating income declined by 2.7%, excluding currency, mainly due to the following three factors, which André outlined previously during our year-end call in February. The impact of the tax-driven cigarette industry volume decline, as well as the related down-trading and our corresponding market share decrease in the GCC, principally Saudi Arabia; higher RRP investments, primarily in the EU Region; and our full-year 2018 contribution of $80 million to the Foundation for a Smoke-Free World, which was expensed entirely in the first quarter. Adjusted diluted EPS of $1.00 declined by 1%, excluding $0.03 of favorable currency. Our reported diluted EPS in the quarter came in $0.13 above the $0.87 forecast that we provided in February. Underpinned by our strong business performance, this better-than-anticipated result was helped by the lower effective tax rate, as well as the timing of certain RRP investments. Nevertheless, our projection of net incremental investment behind RRPs of approximately $600 million in 2018 remains unchanged. Combined cigarette and heated tobacco unit shipment volume declined by 2.3% in the first quarter, or by 1.1%, excluding estimated inventory movements, primarily in Japan and Saudi Arabia. The decline was principally due to lower cigarette industry volume, notably in Japan, Russia, and Saudi Arabia, partly offset by strong growth in heated tobacco unit volume, particularly in Japan and Korea. For the full year, we continue to anticipate a combined shipment volume decline of around 2%, compared to an industry volume decline of 2% to 3%, on the same basis. Heated tobacco unit volume is growing rapidly across launched geographies. In Japan, we lifted the IQOS device sales restriction during the first quarter of 2018. We observed, however, that device sales were slower than our ambitious expectations. This was due to still limited awareness of IQOS' increased availability and, more importantly, to the fact that we are reaching earlier in the year than we had anticipated, the more conservative consumers, especially the age 50 plus smoker segment, which represents approximately 40% of the total adult smoker population. In general, these consumers are likely to display, at least initially, a slower pace in entering the RRP category, that is, they are less likely to be in the 'Innovators' and 'Early Adopters' groups shown on this chart. Instead, they are relatively overrepresented in the 'Late Majority' and 'Laggard' groups, which are larger in size. This is common with any new product category, and especially RRPs, and IQOS in particular, given their phenomenal speed of growth in Japan. We are therefore adjusting our commercial plans in terms of the timing, intensity and content of communication to specifically address the needs of these adult smokers. In parallel, we are strengthening our loyalty programs for existing IQOS users as competition intensifies. However, this temporary dynamic may affect our full-year total heated tobacco unit shipment volume, which we have cautiously reflected in our revised guidance. IQOS continued to record strong heated tobacco category share growth in Japan in the quarter at an estimated 80%, and it is the undisputed icon RRP brand. In fact, as the availability of competitive RRP products has increased, there has naturally been experimentation by certain IQOS users, especially 'Innovators' and 'Early Adopters' with competitive products. This has also been due to the IQOS device sales restriction. However, only an estimated 1% of converted IQOS users fully switch to these competitive products. This is remarkable, particularly given the premium positioning of IQOS, and is a testament to its potential. Before closing on this topic, I think it is important to highlight the underlying growth in heated tobacco unit demand. Even if the aforementioned dynamic persists, we remain on track to double our worldwide in-market sales of heated tobacco units compared to 2017. Moving to our market share performance, total international share, excluding China and the U.S., increased by 0.4 points in the quarter, driven by higher share from our heated tobacco brands, which were up by one full share point to 1.5%. Over half of the 0.6 point share decline for our cigarette portfolio was due to Saudi Arabia, where the decrease in cigarette industry volume and related downtrading put pressure on the shares of both Marlboro and L&M. I will now discuss a few of our key geographies, beginning with the EU Region. Total industry volume declined by 4.1% in the first quarter, or by 3.4% excluding estimated inventory movements. The decline was due mainly to the impact of price increases, including sizable excise tax-driven price increases in France. For the year, we anticipate a total industry volume decline of approximately 2% to 3%, consistent with the structural decline rate. Our total regional market share was down by 0.2 points in the quarter, largely reflecting the impact of estimated inventory movements, partly offset by the strong growth of HEETS, which reached a regional share of 0.8%. As expected, regional adjusted operating income, which declined by 15.8% on a currency-neutral basis, was heavily impacted by incremental RRP investments. For the year, we anticipate adjusted operating income growth in the low to mid single-digits, excluding currency. In Russia, total industry volume declined by 8.3% in the quarter, due mainly to the impact of price increases and higher illicit trade. For the full year, we expect a total industry volume decline of approximately 7%, consistent with 2017. Quarter-to-date February cigarette market share declined by 1.1 point, primarily due to our low-price brands. Despite continued downtrading in the market, as well as adult smoker out-switching to IQOS, share for premium Marlboro increased by 0.4 points, while share for above premium Parliament was down only slightly. We recorded a favorable pricing variance in the quarter, reflecting the annualization of 2017 price increases, as well as additional price increases earlier this year. While this is a welcome development, the pricing environment remains a watch-out, particularly after the scheduled excise tax increase in July. Turning to Saudi Arabia, cigarette industry volume remains under considerable pressure following the June 2017 excise tax-driven price increases. First-quarter industry volume declined by over 40% and was impacted by a further VAT-driven price increase in January. Our cigarette market share declined by 12.5 points, largely reflecting the impact of significant industry-wide downtrading following the price increases given the premium positioning of our portfolio vis-à-vis competitors. We anticipate a moderation in the cigarette industry volume decline in the second half of the year when the June 2017 price increases have been lapped. As I mentioned earlier, the market nonetheless remains a watch-out along with the broader GCC, due to the differing stages of tax enactment. In Indonesia, cigarette industry volume declined by 2.3% in the first quarter, largely reflecting the soft consumer spending environment coupled with above-inflation excise tax-driven price increases. For the year, we continued to anticipate an industry decline of 1% to 3%. Cigarette market share increased by 0.2 points in the quarter to 33.2%, driven by the strong performance of Marlboro Filter Black, as well as Dji Sam Soe Magnum Mild, a lighter-tasting machine-made kretek line extension from the Dji Sam Soe brand family, launched in May 2017. In the Philippines, excise tax-driven price increases drove further profit growth in the quarter. We also recorded strong market share growth, led by Marlboro and Fortune. We are particularly pleased by Marlboro's performance following its price increase in December 2017. We continue to be very encouraged by the outlook for profit growth in this important market. I will now turn to the performance of IQOS, beginning in Japan. HeatSticks continued their strong sequential growth trend in the first quarter, reaching a national market share of 15.8%. This represents growth of 8.7 points and 1.9 points versus the first and fourth quarters of 2017, respectively. Looking at IQOS's performance in Sendai specifically, HeatSticks' off-take share growth in the first quarter continued to drive an increase in our heated tobacco category share. It is worth highlighting that the category’s share growth in the first quarter was driven primarily by IQOS. The quarterly share progression of HEETS in Korea also continues to stand out, reaching 7.3% in the first quarter. To put this performance into perspective, HEETS is now a top-5 tobacco brand in Korea less than one year after launch, with a quarterly share approaching those of our leading cigarette brands in the market, Marlboro and Parliament. Outside Japan and Korea, we continue to record strong sequential national share growth in other advanced IQOS launch markets, with first-quarter market shares ranging from 1.5% in Italy to 3.5% in Greece. This performance demonstrates that we are successfully leveraging our learnings across markets to drive improved execution, higher IQOS awareness and strong conversion. It is important to also remember that these national shares have been achieved despite not having a full national presence in these markets. We believe that the even higher quarterly off-take shares in focus cities such as 3% in Rome and 5.9% in Athens augur well for IQOS in these markets going forward. As seen on this chart, we are observing similar trends with our focus area off-take shares in IQOS launch markets that remain more targeted within a limited number of key cities. This gives us further confidence that our investments behind the heated tobacco category are increasingly paying off. The growth of our RRP portfolio, coupled with the enduring strength of our combustible tobacco brands, is supporting strong anticipated cash generation in 2018. For the year, we continue to target operating cash flow of over $9 billion. We plan to use this cash primarily for capital expenditures to support the growth of our business and for dividends, at the Board’s discretion. We anticipate capital expenditures of approximately $1.7 billion this year, with RRP-related investment expected to account for around 60% of the total. We remain committed to restoring, over time, our leverage multiples to the ranges associated with our current credit rating. Importantly, both Moody's and S&P have recently confirmed our rating, with S&P revising its outlook from 'negative' to 'stable.' In conclusion, our first-quarter results came in better than expected, with the delta compared to our February forecast driven mainly by a lower effective tax rate and the timing of certain RRP investments. Our leading combustible tobacco portfolio continues to support strong pricing while contributing the lion's share of our earnings and cash flow. In parallel, IQOS is recording strong sequential quarterly share growth across launch markets, demonstrating our ability to effectively invest and apply learnings in a wide range of geographies. Finally, the full-year outlook for our business remains strong. Our increased 2018 earnings per share guidance reflects a growth rate of approximately 8% to 11%, excluding currency, compared to adjusted diluted earnings per share of $4.72 in 2017. Thank you. I am now happy to answer your questions.

Thank you, hi everyone. So Martin I had a few questions just in terms of how the IQOS trends played out in the quarter. So, first just in Japan how much did device sales actually come in lower versus your expectations and is this is something that developed in the last two months because it sounded like CAGNY trends were pretty strong, I think you had January market share number for IQOS that was higher than the quarterly average. So, just curious in terms of the device sales situation and then if this is something you have observed in the last two months?

Yes, if you remember during our end-of-year call, we indicated that we expected to meet the additional HeatStick units inventory we sent to Japan with extra devices from our second supplier that increased production. We did ship these additional devices and anticipated a significant surge, as we had been short in the market for some time. However, it turned out we were closer to meeting market demand than we realized. We expect to reach a plateau later in the year since we noticed consumer dynamics indicating we are nearing saturation among early adopters and innovators. This shift is occurring a bit earlier in the year than we expected, which is not unusual. We have analyzed trends from other product launches and often see a period of rapid adoption followed by a plateau before growth resumes. We believe we are at one of those points now. We will adjust our plans accordingly and will implement several initiatives in Japan sooner than planned, as well as modify our messaging to consumers. We are uncertain about how long this plateau will last; it may be followed by a return to better growth rates quickly, or it might persist throughout the year. Therefore, we deemed it wise to reserve some benefits from tax to factor in this situation, along with the pricing in Saudi Arabia and Russia. We will monitor how things progress. It's early in the year, and we have a strong team in Japan addressing these challenges, supported by experienced personnel in the region. Our headquarters team is also developing solid strategies to engage other consumer segments. We remain optimistic about Japan, having experienced incredible growth there, achieving about a 16% market share in a short timeframe, which is remarkable. The only concern was whether this rapid growth would continue or if we would need to adjust our approach to consumers, and that adjustment is happening a bit sooner than we had hoped.

No, go ahead sorry.

You had mentioned the shares, for the quarter we are at 15.8 versus the quarter four last year of 13.9. I think you mentioned the January share that probably you were looking at from CAGNY which was given at 16.3. We're focusing more on quarterly shares because there's always a bit of noise in those in market shares there based on exchange of data from the different companies and sometimes there are some inventory impacts as they shift to retail. If you look at December of last year the in-market shares percent was 14.1 so it was probably a little understated versus due to some inventory increases from our competitors and then 16.3 came in in January probably a little overstated because of the reversing of that effect. But if you look at say quarter end to quarter end so December was the last month for Q4 at 14.1, March of this quarter is at 15.6 so we're seeing a good trend in Japan in off-take. What we're flagging for the rest of the year isn't really you don't see it in the first quarter numbers. What we're really flagging is the growth, the speed of uptake of new consumers as measured by how quickly they buy the devices and rather than get a big surge from pent up demand that we had optimistically estimated we're seeing still good growth, still a good number of new consumers coming in the category. We just don't have that surge there of devices and therefore we can project forward and see that our HeatStick sales which come as a lagging indicator to the device sales are likely to be a little bit lower than what we had flagged at the year-end call and therefore we're being cautious in reserving some ammunition to deal with that.

Okay, and then if I can just clarify the distortion though between the in-market sales number versus the shipment number because it seems like last year particularly in the fourth quarter, there was a bigger sort of over-shipment of IQOS versus the in market share number. So as you think about the kind of a little bit slower adoption of the more conservative consumers and then you also have this big inventory that's probably still in transit or somewhere in the channel. How do you think about accounting for that as you think about shipment volume in 2018?

Let me take a moment to revisit what we discussed before and provide some context. We began last year with minimal inventory due to delays with HeatSticks, and only later in the year were we able to start replenishing. We indicated in Q3 and Q4 that we were building what we believe is an appropriate inventory for Japan. For the full year, we built an inventory of 8.5 billion net of conventional cigarettes. In Japan, we aimed to ensure an adequate supply of heated tobacco units while reducing our conventional cigarette inventory. Specifically, we highlighted 5 billion in the fourth quarter and a total of 8.5 billion for the year. During this time, we transitioned from air to sea shipments, while still depending largely on one factory, which meant we needed to keep a safety stock to manage any potential disruptions. We anticipated growing demand for HeatSticks, which became a bottleneck in the latter half of the year. It was clear that last year's figures included a buildup of inventory for heated tobacco units in Japan. For this year, we have that inventory established and do not expect it to decrease as we are not dealing with excess inventory. Our inventory is suitable for a fast-growing product category and aligns with the long supply chain. We have switched to sea shipments to protect against possible supply chain disruptions, which remains relatively new and focused on a single factory. In 2018, you will see stable HeatSticks inventory in Japan, and the inventory build will be lower this year compared to 2017. Keep in mind that we are now shipping by sea from Japan, meaning that products on the water will be recorded as revenue when they leave Europe, which takes six to eight weeks to reach Japan. There may be some confusion with the Japanese government import data in the quarter, which was misinterpreted as IMS sales. However, these were actually shipments from the fourth quarter of last year that arrived in January and February of this year. This could be another reason for the disparity between our in-market sales and shipments.

Got it, okay. Thank you.

Okay, thanks Judy.

Good morning. Can you elaborate on what has changed in Russia and Saudi Arabia? These issues aren't new, but it appears they may have worsened, and is that part of what you attribute to your revised revenue outlook?

Okay, sure. So for Russia it's more a situation that we still have a lot of the year left to go with the pricing situation and we still have the tax increase which comes only in July this year which is a pass on of five Roubles per pack. So it's lower than it was last year but it's coming six months later. So the whole pricing situation in Russia is still unfolding. The first quarter actually came in pretty good. We're on track, there is no big new news there. But we have a situation in Russia where the timing between when the price is announced and when it actually reaches retail is quite long in Russia because of the way the pricing happens, it has to be declared at production and then there's inventory that works its way through the market. So the time between now and the end of the year with the tax still to come and the pricing having such a long time to retail, we just called it out as a caution and something that we are still watching and concerned about. But there is really not a big new development. You always have the usual skirmishes or lagging from competition and certain SKUs perhaps not coming up in price quite in the way that others are. That's normal so it's not really new news. On Saudi I think it's a story where we're just now seeing the full impacts of the volume effect of these huge price increases. We had another price increase in January driven by the VAT. Our market share in Saudi is actually sequentially starting to recover a bit. In Q3, Q4 we were in the 35% more or less market share range. So while Q1 is way down versus last year sequentially it's actually starting to recover. The watch out is more on the market volume which is still not in recovery mode which is still lower in Q1 than it was in Q4 and Q3. So again it's a situation where it's very hard to predict the rate of recovery of the total market volume and our share and it's still early in the year so we're calling it out as a caution. Again we're not seeing numbers that are dramatically different from what we had expected but it's still very early days and we want to make sure we have that accounted for rather than just roll it on through to the guidance and then have some news later.

Can you clarify something for me? When you initially reported your fourth quarter and provided guidance, that was earlier in the year, right? I'm understanding correctly that nothing has changed, so is the updated revenue forecast primarily influenced by IQOS in Japan?

What, I mean certainly IQOS in Japan is probably the piece that's more newer information coming from the way that the device offtake is occurring. But we're still anticipating a very successful year in Japan and we're still anticipating double the volume of heated tobacco unit sales worldwide. I mean but clearly if this situation in Japan persists then our volume estimates for heated tobacco units will be more in the range of 55 to 60 versus the over 60 that we had called out before. It's hard to say exactly at this point, we don't know how this trend or the dynamic is going to develop. But we are just calling out kind of a more cautious situation to give us the time and the resources to tackle these different consumer segments in the right way.

So, help me understand the IQOS number then 55 to 60 is quite different than twice last year's number which would be more like 70. I thought you were just saying today that something in the 2X last year was where you thought it might be?

We expect our in-market sales to be more than double what they were last year. I'm factoring in the inventory build from last year and comparing that to our anticipated sales this year, which we expect to significantly exceed last year's total. A more cautious estimate would put the figures around 55 to 60 if the current trends in Japan continue. However, we are also experiencing substantial growth in other markets, with notable share growth and volume increases across the EU and improvements in Russia. Overall, we have positive developments for IQOS and our heated tobacco units worldwide, but Japan represents a significant portion of our volume, so we think it's prudent to adopt a more cautious approach in our projections.

So can you just help us understand, I know you're learning as you go and this is an evolution in your business that's quite new but where do you see this going and how do you model next year or two, three, four, five years out. You must have some amount of planning around that, what could an investor expect for what this all gets us and where we're heading?

I'm sorry Michael, it's very hard to understand you. I don't know that you have a very good connection or something. I took away you are asking about how do we model our for the years, is that…

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

I'm sorry I can't hear the question at all. So I don't know Michael you just have a bad connection maybe you can call in again. We can go to another and come back. I can't get the question.

Yeah I can try that and maybe if you can hear me now just one more time to what's the outlook like two, three, four years out, how do you see your business evolving. Obviously there's still some learning you're doing but what is the end game for where we're heading?

Well, I mean we're building a whole new category not only for IQOS but we will be doing the same thing across our entire RRP portfolio. You have heard our commitment as a company to move as quickly as we can our entire combustible business to reduced risk products. We're investing substantially in building the infrastructure not just centrally but in the markets to make this happen. So we are very committed to this. We have a strong portfolio of products not just with IQOS but with other platforms as well. And as IQOS continues to do well in these other markets we expect the volume to keep growing extremely quickly as we make this happen. At the same time we're not abandoning our conventional product focus. You see we're getting very good results from our portfolio, our pricing in the first quarter is right on. We said that for the full year on the conventional side we would achieve 7% pricing variance as a percent of the combustible prior year net revenues and in the first quarter we're right on track for that doing extremely well. The volume is okay. We're getting some volume back in some markets where we had lost it in Asia and overall we're using the combustible side to fund this transformation to reduced risk products and as far as modeling how fast that will go it's difficult. We've said there is uncertainty in this, we're going to move it as fast as we can but we're also prudent at the speed at which we invest to make sure we're getting a good return for the investments and so forth. So as far as modeling it out several years, if you figured it out, have a good model we'd like to look at it too.

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

Regarding the margin outlook, in the first quarter, we experienced a significant decline in our margins, dropping by about four percentage points. If we break that down, approximately half of that, or around 2%, is due to the impact of our device sales, which were higher than we typically expect. We had estimated that device sales would comprise about 25% to 30% of our net revenues, but in the first quarter, it was about 35%, which is five percentage points above our range. This was influenced by devices from our new supplier that were shipped to Japan, and although our results were solid, they did not sell as quickly as we had anticipated. The higher device percentage in the first quarter compared to previous quarters accounts for part of the margin decline. Additionally, the situation in Saudi Arabia is contributing significantly to the margin challenges, as it is a high-margin region and we've seen a substantial negative impact there. There is also an $80 million annual foundation cost that affected us in the first quarter alone. These factors collectively explain the four percentage point drop in margins. However, in regions not affected by these issues, we achieved strong margin expansion in South and Southeast Asia, Latin America, and Canada. Furthermore, our substantial investments in RRP, particularly in the EU, are aimed at various markets worldwide. Looking ahead, we expect some of the pressures observed in the first quarter will lessen. We will continue to invest, particularly in new consumer acquisition and necessary transitions. A portion of this increased spending relates to infrastructure, which, once established, supports larger volumes without requiring proportional growth. As we move forward, while our investments will increase, the ratio of investment to new consumers should become more manageable. We also acknowledge a time lag in returns; significant investments aimed at gaining consumers in the EU may not yield immediate payback, with most benefits expected next year. Next year, we anticipate a more favorable situation since the foundation costs will be integrated into our base, device costs are declining, and we expect to no longer face the same challenges in Saudi Arabia. Overall, considering these factors, we believe that margins and overall business performance should improve in 2019.

Okay, thanks for your time.

Thank you very much. I have a quick question regarding Japan, but my main focus is on the E.U. To address the Japan question first, in response to Judy, you mentioned a phrase that was not clear, and if you look at the month-to-month market share, it seems to be declining.

Adam, this is Nick. We have a very bad connection, we're going to just switch to a different phone so if you can just hold on one second we will just make the switch. Gloria can you switch us, the operator can you switch us to the backup line please.

Or I could email you the question.

We want to hear it from you.

Can you can you hear me?

Go ahead Adam, thank you.

On Japan, I want to clarify that you still expect to see growth in market share despite it sounding flat and that the monthly market share in Q1 worsened over those three quarters. Am I correct in understanding that you anticipate market share growth throughout 2018, quarter by quarter?

Yes, we are experiencing growth in Japan, gaining new consumers, and we expect our market share there to keep increasing. The pace of growth hasn't been as rapid as we anticipated, particularly with the recent lifting of the cap and our ability to meet the demand for HeatSticks. However, we are still growing, and our product is performing well with strong conversion rates. We are also competing effectively in the heat-not-burn category, increasing our segment share. The challenge lies not in our growth but in the speed and timing of reaching certain consumer groups, especially those over 50, who make up a significant portion of adult smokers. We are seeing slower adoption in this demographic, but we believe they will eventually come around, as demonstrated by those who are already using our product. It’s just a matter of timing.

Thank you very much. I would like to ask about two related questions regarding the E.U. Firstly, it seems you had plans to make some investments in Q1 but ultimately chose not to. I would be very interested to learn more about what those plans entailed. Secondly, I see that market shares are improving, moving from 0.6 in Q4 to 0.8 in Q1. How do you anticipate this trend will continue? Do you expect to see an acceleration throughout the year, or do you think this rate will remain steady each quarter? Thank you.

I mean when it comes to investments I mean whenever you put plans together to have a big step up in investment it's always built on project timelines and when you can execute things and so forth. It's not so much the case of deciding not to move forward, it is more the case of our ability to pull off this big surge in investments and to get the resources lined up and get it executed. I mean obviously we're making choices on putting more money or less money into individual markets depending on how the return on investments is coming and obviously there are times when we try something it doesn't work and we shift the resources over to another project that is working. But I'm not going to get into specifically calling out which things are working and which ones aren't working because I certainly don't want the competition to gain that information. As far as the speed of growth in the EU I mean it's hard to predict, we're seeing better results. We are very pleased with the way things are moving and the increased rate of growth. I mean in Italy where we've been for quite a while it was moving along at 0.1 at best month to month, quarter to quarter and now we're accelerating a bit. There are a number of other markets where the results are pretty fantastic. Greece is another so it's very difficult though to sit here and give you a rate of progression across the EU. I mean we're going to continue to invest. Overall this year we're still on track to achieve our $600 million step up which is net of conventional product allocation. So it's a considerable sum. We're trying very hard to spend it wisely, we put in place controls and tracking to make sure that that the money is getting results before we release more of it and that we reduce programs that aren't working. And the money and the investments not only in EU but in other places as well, Russia is a fantastic example, it's really starting to pay off. And the learnings are coming and we are getting better at executing, the quality of the coaches that we've put in place in a number of markets is much better, the messages are being fine-tuned by market to fit the differences of consumers. So we're really pleased with what is going, we're very optimistic about IQOS growth across the world by the way not just EU but it's in many other places as well. We're seeing terrific results in quite a few markets. So the plan is working and the move towards a reduced risk product is working. We're very mindful though of keeping an eye also on the conventional pieces and not abandoning that part of the business because it has to be the engine to provide the resources for the gains that we're going to get on RRP. But you see it worldwide. Our share in RRP was up one full share point year-over-year. I mean if you looked at that and said this was like a new brand rolling out across the world everybody would be jumping up and down with tremendous joy and it is. It's pretty fantastic and so we're very optimistic about it.

Thank you.

Hi. Hi guys, I missed a little bit of the call but I did want to talk to you about your HeatStick sales outside of Japan which did increase sequentially but maybe not as much as I would have expected. So I want to hear from you guys if that has met your expectations and how you expect that to ramp as the year progresses especially with what you just discussed in terms of the stepped up spending, conversations you're having with consumers, refining your approach, are you more optimistic that that could accelerate further as the year progresses?

Well Bonnie I'm very glad you have very high expectations and the reality is we do too. And did the first quarter HeatStick sales outside of Japan meet our expectations, yes, they did. We're on track. We do hope to continue to accelerate the growth and that's what the investment is for. Obviously we've got a fair amount more to spend and more to put behind the growth rate and we're getting better at it, we're getting more tuned into what works. We're sharing very good learnings across markets. The new operating structure with the COO, Jacek focused on execution while the development side works more in the future in the tool boxes and so forth is working very well. We're still getting this in place. But we're already seeing some benefits from that and improved execution as well as improved speed at which we're developing the pipeline of new tools and new products to come. We have a terrific plan for the rest of this year and into next year for new products, new initiatives which I can't go into great detail on as you can imagine but yes, I think we're pleased with the results so far and we're very optimistic that we can accelerate the results going forward.

Okay, and then just another question on your top line guidance which changed a little bit as you guys discussed and a few questions, so I wanted to make sure I understand the pricing on HeatSticks, is that something you guys are adjusting downward for instance in any markets as you try to push for the conversion, just kind of wanted to better understand how you're going to continue to position HeatSticks relative to combustible sticks in many of these markets?

Yeah, we haven't changed our plans on pricing for HeatSticks at all. Our main focus of course with IQOS and HeatSticks is consumer acquisition. So at this point we're not pushing to try to get a lot of pricing out of HeatSticks. Obviously we want to maintain its premium positioning so it doesn't mean we won't ever change prices anywhere but pricing isn't really the name of the game at this point with IQOS or with HeatSticks. We've got obviously increased competition in a number of markets so the pricing of the devices and the consumables we have to keep an eye on competition. We are priced well above the competition virtually everywhere which is fine by the way because we have a better product and consumers see it that way. On the other hand we have to be careful that we don't get undercut too much. So we have not changed the pricing on HeatSticks at all. The slight change in the language on revenue growth first of all, I mean we are still seeing about 8% which is pretty fantastic for any company but especially for a consumer products company. So I think this is a pretty terrific number to have out there. We changed it a little bit based on what I already said which is the potential if it persists from Japan for the HeatStick or heated tobacco unit volume to be a little lower than what we had flagged in the previous year. And so we're giving ourselves a little bit of room and range around the 8% and trying to be as forthcoming with everybody as possible so that we don't disappoint on that number. But it's very, very solid number. 8% is nothing I think to be ashamed of.

No, not at all and then just maybe a quick final question for me, I want to circle back to something you just mentioned about new innovation that you expect to be in the market this year which you can't talk about but I wanted to then clarify is that baked into your guidance for the HeatSticks volume as well as are you also considering any volume you might be selling in the U.S. market, is that factored into your guidance?

Well, look I hesitate to go line by line and say what's in guidance and not in guidance because you know as you well know a guidance is a kind of an all in number with a lot of puts and takes. I will say that the U.S. volume is really immaterial for this year. First of all we don't know exactly when it would ship and we don't have any volume in there for U.S. However, when it comes to other programs or other initiatives I mean obviously we have a plan and we know what's going to happen. It's part of our overall assessment of what the business can provide for the year. So for new initiatives and new types of activities of any type we obviously consider them when we're putting together estimates.

Alright, thank you.

Hi, good morning. So, on the top line again, sorry to belabor the issue but that's clearly the concern today. When we think about your full year outlook for 8% and I look at the cadence of revenue growth in 2017 it is hard to imagine if you only did an 8.3 in the first quarter and your comps get considerably harder like what is going to change over the course of the year and allow you to kind of maintain that level of growth when your comps get significantly harder. So help us understand kind of the cadence of revenue growth please over the course of the rest of 2018? Thanks.

Well, I think Q2 and Q3 we are expecting some pretty strong revenue growth above 8%. As you pointed out the real comp hurdle comes with the fourth quarter where we had a fantastic revenue growth last year in the fourth quarter, it was 18.8% I believe if I recall. So that comparison does make it more difficult and that with that in mind that's partly why we're putting out there more around 8% versus saying the over 8% before. But we expect very solid, very strong revenue growth in Q2 and Q3 and continued growth sequentially for Q4 but just the year-over-year comparison becomes quite challenging. I think that's about as much color as I can give you on that one.

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

Well I mean I mentioned that in the first quarter we had good pricing and that we are on our plan for pricing. And in fact slightly ahead. So that's part of it, as the pricing gets rolled in, in the first quarter it is really not fully impacted because we announced pricing across a number of geographies. I mean in the E.U. alone we're implementing pricing in Germany, Poland, Italy, France. I mean and yet we have mentioned the pricing in Russia. As you know Indonesia developed throughout the year, we had pricing in the beginning of the year for Mexico, Canada, Argentina, Philippines, a big piece that's going to be now reflected throughout the rest of the year. So that's part of it. The volumes in the first quarter came in what we expected maybe a little bit better. The conventional cigarette volume is actually holding up very nicely and we're seeing some good developments in a number of markets despite some of the pricing related volume impacts that we're having in Russia, in France and in a couple of other markets. But overall we're doing pretty well on conventional cigarette volume and our outlook for that as well.

Okay, thanks. On your outlook for incremental spend on IQOS relative to I believe it was the $600 million in incremental spend, you had originally guided for. How should we think about you guys kind of tweaking that plan, like what would drive adjustments there given in particular the first quarter trends in Japan, thanks?

Yeah, I mean look we're going to spend what we need to spend particularly in Japan. We have a rocket ship there that is absolutely taking off and very, very successful. And we will put the resources into it that we need to and which we think is appropriate. There are various ways to do that right, you can reallocate from the spending you have in other areas around conventional and other programs. You can reallocate some geographically or if necessary we can also spend above that $600 million that we mentioned. And this is part of the reason we are holding back a bit of the tax benefits that we called out as far as our guidance increases. So that we have the flexibility and the ability to put the resources behind a very successful product that we have not only in Japan but elsewhere. So yes, right now we don't call out an increase in spending from the $600 because first we want to look at our reallocations and putting our heads together to put more resources where we need it without increasing the total net increase. But in the end of the day if we need to we will spend what is necessary for these new initiatives in Japan. And we'll find a way to deal with that within the guidelines that we've given you on the guidance.

Okay, thanks. Last one for me please. As we think about that Roger's innovation adoption curve that you showed for Japanese consumers like where do you think it kind of breaks and you say, okay, you know what like we're probably at saturation on IQOS and these older cohorts maybe are more appropriate for like a platform too, how are you guys thinking about that balance?

I don't believe that late adopters or laggards won't transition to heat-not-burn products. We actually observe high conversion rates among those groups, although it requires more effort and time to explain how the product works, how to use it, and its benefits. We're increasingly becoming mainstream with IQOS in Japan. With a 16% market share, it's widely used and recognizable, which makes it a viable option for anyone. However, it may require more explanation, training on usage, and tailored messaging regarding the benefits. We are fully confident that IQOS can be successful among those aged 50 and older or other groups we identified. The key lies in how we approach them, the programs we create, the messages we convey, and the products we offer. We see strong potential for IQOS among these consumers. Over time, a wider product platform could play a role in these markets, allowing us to engage different consumer groups and even target individual consumers based on their preferences at different times of the day. Our entire product portfolio can help us connect with diverse groups and address individual needs at various times throughout the week. We believe we will continue to grow in Japan, where the product is becoming more mainstream, necessitating a different strategy. The rapid word-of-mouth that characterized early adopters and innovators has slowed, as most from these groups have already engaged with the category, indicating near saturation. However, we will also focus on these other groups and are confident we will succeed, though it's uncertain how quickly that will occur.

Okay, thank you.

Hi, good morning or good afternoon. Just a couple of quick questions, one quite specific one in Japan just out of interest how many of the devices are now sold at full price and how many are still being sold on discount when it comes to IQOS?

An increasing percentage is sold at full price because the original design was that the discount was more for encouraging people to register a new user. So you see consumers buying a second device which is positive from the point of view that they are more attached to the category and they see a need for additional devices and you also see some replacements because remember we've been in Japan now for over two and a half years. So you have devices that reached the end of their number of cycles that need to be replaced. Right now in Japan it's actually more than 50% is sold without the discount. So it's moving slowly in that direction. At the same time we have to realize that to attract new consumers especially getting back to the 50 plus age group there's a little more price sensitivity in that group as well. This group tends to buy brands which are a little bit lower price and so they are more sensitive both on devices and on the heat sticks. So having a good offer for them and a good opportunity for them to try especially for their initial devices is important to cracking that group. So we will be judicious how we use discounts but I think we have to be realistic that we have competitors out there offering their HEET number and usually at 30% or 40% below the lowest prices we're offering for our. So we have to find ways to also put our products in front of people that are a little more price sensitive as we go forward.

Just to take that a bit further I mean, in the past you've talked about potentially producing lower priced brands, HEET is sort of premium brand and maybe producing sort of more comparable and in pricing terms with some of the competition, is that what you're referring to here potentially a whole new brand or you are referring to sort of just a more heavy discount on the existing brand?

Well I think as you can understand I'm not going to go into details for competitive reasons on our plans. But in the long run, over the long haul you're going to have to find ways to approach different consumer groups and you can do that in many different ways. You can do it with different products, you can do it with different offers, you can do it with special offers, etc. So I'm not going to go through the exact plan but that obviously we're thinking about ways to crack different consumer groups many of which are going to be increasingly price sensitive.

Another quick question on IQOS, clearly the experience in Japan has been that the flavors of the menthol and so on where they are sort of most popular, are you finding a very similar experience outside of Japan or was the consumer reaction to IQOS perhaps to use the more non-mentholated or non-flavored versions, is that a traditional taste?

Yeah, I mean I think it depends on the market and markets that have a menthol category. The menthol version is usually preferred by menthol smokers quite obviously. Often though we do see the menthol over-index a bit simply because it's a bit easier taste to bridge to from conventional to go to IQOS because IQOS is a much lighter taste and it's a flavor that people have chosen in a bit higher percentage than usually the menthol in the market. But it depends greatly on the different market and the different situations.

Right, because it does vary, the experience does vary by market quite considerably then?

Yes, it does.

Yeah, and a quick one on the FMC side, am I reading this right, the volumes in Pakistan sort of doubled and that added 8.4 billion units, is that correct?

Yeah, there's couple of things going on in Pakistan. First of all if you recall in May of last year we were successful in working with the government to establish a new tier, a lower tax tier in order to pull back the volume that had been lost to illicit trade. Because they had raised taxes so much and prices so much and the illicit trade being actually local producers that weren't paying taxes had grown tremendously. So in May of last year this new lower tax tier was implemented and we were able to put products there at a price that could pull volume back from illicit trade together with the competition. The second piece is in 2016 there was a big inventory load in the market associated with a big price in tax anticipated. So in 2017 first quarter there was very little volume sold or relatively low volume sold in the market. So you're looking at two aspects; one is volume coming back from illicit trade which is roughly half of that 8 billion number you're mentioning and then the other half of it is the comparison year-over-year which is an inventory effect from the very high volume sold in fourth quarter 2016 with a very low volume in first quarter 2017 to more normalcy in the first quarter of 2018. So the market was quite distorted by both of those two events. The good news in Pakistan is we do have the legal volume recovering substantially from what was a pretty dire situation with the illicit trade taking a lot of that volume out. So that's a very positive development and our market share by the way in Pakistan has improved as well from this whole situation.

Okay, and very quickly last one, just wondering are there any sort of hated lawsuits pending regarding any other competitors related to IQOS in terms of the design of the product, is there any legal procedures outstanding against anybody in terms of sort of copyright?

Look we worked very hard to defend our intellectual property. We constantly are looking at what competition is doing and looking at potential legal remedies in cases where we think they are misusing our IP but I'm not going to comment on individual cases or individual actions that we have either pending or out there at this time.

Okay, thanks very much.

Hi Chris.

Hi, good afternoon. I know we're nearing end of the call here, I will just be quick here with two questions. The first is can you say how much of the spending you planned for the first quarter is in the future quarters, is it a symbol of the EPS beep that occurred in the quarter that could push into Q2 or spread across the next three quarters?

Yeah, I mean we flagged the difference between the $0.87 that we had forecast and the dollar it's about $0.03 coming from the difference in the tax rate and the rest is overall spending-type stuff. I mean the business by the way was very good in the first quarter. Our revenues came in well, pricing is doing great. So we had a good robust quarter but most of the difference is the tax and it's actually the spending than the tax. We still think the spending will be the same more or less is what we said before. So obviously what we didn't spend in the first quarter we still plan to spend in subsequent quarters. I'm not going to give you the exact amount or the exact timing of it partly because these plans are still unfolding and we're still allocating the resources and deciding which projects are most successful and deserve more funding and so forth.

Okay, to clarify the structure of that spending, you mentioned increasing investment in existing IQOS users in Japan. Does this mean that the higher spending in Japan for customer retention is coming at the expense of new developments in other markets, considering the overall $600 million budget for spending?

I'm not going to go through the exact regional split or country split. All I'm trying to flag is that we will do what we need to do in Japan. In other words, we're pulling forward some of our plans so in some cases just timing of what we're planning to spend anyway. In other cases we may need to put some additional resources in there which we can fund in a number of different ways including taking it from the conventional business. It's a big company. We have adequate resources to redeploy some to trouble spots or to get opportunities going which has been more as an opportunity. But does that mean we're going to for instance cut spending in EU behind IQOS in order to do that, I don't think so. I think it's more an issue of figuring out what programs work and where to spend it and so forth. So I'm not going to give you the exact split by the market and by the region but we will do what we need to do to get IQOS fully successful which it is doing already and we need to continue.

Operator do we have any questions left?

Alright, thanks for taking a follow up. I just had two quick questions. One, I mean obviously your stocks down pretty meaningfully today, your ratings have gotten better, you've got some cash overseas, so I'm just wondering if you can revisit the share buyback earlier than perhaps you had envisioned? And then secondly just on Japan, I guess the bigger question to me is whether you've just overestimated how big the market can get ultimately and basically we're already seeing market share kind of plateau and it's not necessarily an early adoption issue but that's basically how big the market can get. So how do you get comfort around that there was actually a bigger demand out there?

Okay, I mean first of all on the share we've said we won't have a share buyback in 2018. We're working to improve our leverage and make sure we have the flexibility also within our balance sheet to be able to make for example acquisitions of new technology and in the reduced risk area if necessary. If currency continues favorable or gets more favorable and stays that way and we continue to see the success in the business that we're having at some point we're going to have to sit down with the board and decide what's the best way to reward shareholders whether that be dividend increases or whether it be stock buybacks. It's really a Board decision and we haven't got to that point yet. But at some point in the future that will come. As far as Japan you know look, what we're seeing is that the conversion rates for example continue to be very strong. We think that as we approach consumers and have the ability to talk to them and convince them of the product that we can still continue to grow this category. We don't think there's some artificial plateau that is sealing and we won't be able to grow beyond that. We think it's more a matter of the speed at which you can move, the resources it'll take to do it, and the messages, tools, approaches, products that are customized to each of the different consumer groups to keep growing. We don't buy the idea that there's a big chunk of consumers that want to continue using combustible cigarettes when offered extremely high quality satisfying reduced risk products. It just doesn't make sense. Every single adult smoker that has the right product to shift to has a cleaner way to use nicotine, we think can eventually make that shift. And we've seen it among our own employees, we've seen him on every market where we go and work on it, we are seeing among our friends where we go and you approach them by and convince them that this is a better way for them to use nicotine and get them to commit to using it for a certain period of time. The conversion rates are fantastic so we don't buy the idea that there's some sort of a limit. Now it may take longer, it may take more resources, it may take more customized approach but this is an unforeseen. We knew that we were going to have to adjust as we hit different consumer demographics and consumer groups and that's kind of where we are. This isn't surprising, okay it came a little bit earlier in the year than what we had hoped. That's just how it is but that's okay. We've got the right team and the right products and the right approach and we're going to keep growing in Japan.

Okay, thanks.

Well thank you very much for joining us. This concludes our call for today. And if you have any follow-up questions please contact the IR team. Have a great day. Thank you.