Philip Morris International Inc. (PM) Q3 2012 Earnings Report, Transcript and Summary

Good day, and welcome to the Philip Morris International Third Quarter 2012 Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by Philip Morris International management and the question-and-answer session. [Operator Instructions] I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2012 third quarter results. You may access the release on our website at www.pmi.com. During our call today, we will be talking about results for the third quarter 2012 and comparing them with the same period in 2011, unless otherwise stated. References to volumes are to PMI shipments. Industry volume and market shares are the latest data available from a number of internal and external sources. Organic volume refers to volume excluding acquisitions. Net revenues exclude excise taxes. Operating Companies Income or OCI is defined as operating income before general corporate expenses and the amortization of intangibles. You will find data tables showing adjustments to net revenues and OCI for currency, acquisitions, asset impairment, exit and other costs, free cash flow calculations and adjustments to earnings per share or EPS, as well as reconciliations to U.S. GAAP measures at the end of today's webcast slides, which are posted on our website. Today's remarks contain forward-looking statements and projections of future results, and I direct your attention to the Forward-Looking and Cautionary Statements disclosure in today's presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. It's now my pleasure to introduce Jacek Olczak, our Chief Financial Officer. Jacek.

Thank you, Nick, and welcome, ladies and gentlemen. We remain confident that the fundamentals of our business are solid despite the difficult comparisons in the third quarter that we have previously discussed. We expect to achieve our annual organic volume growth target of 1% and adjusted diluted EPS growth in line with our mid- to long-term constant currency annual growth target for the full year 2012. Today, we narrowed the range of our 2012 reported diluted earnings per share guidance to $5.12 to $5.18 compared to $4.85 in 2011. This guidance includes unfavorable currency of $0.23, a tax charge of $0.05 related to the closing of the U.S. federal income tax audit for the years 2004 to 2006 and $0.02 of asset impairment and exit costs. Excluding the impact of currency, the aforementioned tax charge and asset impairment and exit costs, our guidance implies a growth rate of approximately 11% to 12% compared to an adjusted diluted EPS of $4.88 in 2011. Let me remind you that if we exclude the $0.10 hurdle due to Japan in 2011, the growth rate would be even higher at 13.5% to 14.5%. Our revised guidance also reflects the increased investments in marketing, sales and distribution, particularly in the Asia and EEMA regions. Turning to our third quarter results. We posted our strongest-ever quarterly results this time last year with organic cigarette volume growth of 4.4% and adjusted diluted EPS up 33% on a currency-neutral basis. As expected, therefore, our third quarter results this year suffered from these very tough comparisons with organic cigarette volume down 1.3% and adjusted diluted EPS up only 5.8% on a currency-neutral basis. Through the end of September this year, we have achieved strong results with organic cigarette volume up by 0.7%. Excluding currency and acquisitions, our net revenues and adjusted OCI have increased by 5.4% and 6.9%, respectively. Adjusted diluted EPS has grown on a currency-neutral basis by 10.9%. Let me now move to the European Union where economic conditions continue to be very difficult. Unemployment continues to rise in the southern European countries, most notably Spain. Consequently, tax-paid cigarette volumes were down at a double-digit rate in the quarter in Greece, Spain and Italy, while in contrast, the decline in Germany was a much more moderate 2%. For the EU region as a whole, the decline was 7.5%, an improved trend compared to the second quarter, and down 6.5% through the first 9 months of the year. For the full year 2012, we still expect that cigarette industry volume will decline by about 6%. A key component in the decline of the duty-paid cigarette market in Southern Europe has been adult smokers switching to lower-taxed fine cut products and to illicit cigarettes. This can be illustrated by Italy where the duty-paid cigarette industry volume declined by 10.1% during the third quarter, while fine cut grew by 41%. In addition, the incidence of nondomestic illicit trade for 2012 in Italy is expected to reach approximately 9%, up from an estimated 6.5% in 2011. Our business performed very well in this difficult environment. Marlboro gained 0.8 points in the quarter to reach a cigarette market share of 23.5%. This was sufficient, along with the 0.4 share points gained by Philip Morris Selection, to more than offset the share decline of our traditional local brand, Diana. Overall, PMI's market share rose by 0.2 points to 53.2%. We are now also the leader in the fine cut category and doubled our share to 27.2% behind Chesterfield and the launch of Diana. In Germany, where unemployment remains low, cigarette industry volume declined just 2% in the third quarter, while sales of fine cut products increased by 2.3%. These robust trends took place despite tax-driven retail price increases earlier this year and were due in part to a reduction in border sales. Marlboro continued to gain share in the cigarette category in the third quarter, up 0.2 points to 21%. With L&M essentially stable at 10.2%, our overall cigarette market share was in line with 2011. In the EU region as a whole, economic conditions will remain difficult until the issue of unemployment is tackled. In the third quarter, our cigarette shipments declined by 8.1% or 4.6 billion units, driven by the 7.5% decrease in the industry volume. Our fine cut volume in contrast increased by 15.2%. The drop in our cigarette volume can be in large part attributed to an increase in illicit trade, particularly in southern European countries where total tobacco smoking incidence levels have remained relatively stable. We are very pleased by the performance of Marlboro in the quarter. In an obviously difficult environment for premium brands, Marlboro was able to expand its market share by 0.4 points to 18.4%. Marlboro's share grew not only in Germany and Italy but also in markets such as Belgium, Greece and across Central Europe, notably Poland. L&M remained resilient despite a 0.2 share points decline to 6.5%, attributable to adult smokers up-trading to Marlboro in Greece and Poland. Chesterfield gained 0.3 points to reach 3.5%, reinforcing our overall position in the low-price segment. Overall, our cigarette market share remained stable at 38.1%, while we further expanded our position in fine cut, adding 0.6 points to reach a category share of 13.4%. Across the EU region, our pricing remained strong, the latest increase having taken place this month in France. However, the positive pricing variance was insufficient to offset the volume decline. Net revenues and adjusted OCI, excluding currency, were consequently down by 1.9% and 2.9%, respectively. This also reflects the continued investments behind our brands and field sales force. In the first 9 months of the year, adjusted OCI on the same basis has decreased by just 0.9%, and we remain confident that we should be able to achieve an increase in profitability, excluding currency, in the EU region for the full year 2012. Our results in the Asia region were impacted by the difficult volume comparisons in Japan and Korea, where our shipments grew by 47.1% and 22.4%, respectively, in the third quarter of 2011. We also faced challenging comparisons in Indonesia, where we achieved a 22.5% volume increase in the third quarter of last year. Nevertheless, our volume this quarter in Indonesia grew by a further 13% as we continued to increase our share in this growing market. Adjusted OCI, excluding currency and acquisitions, grew by 1.2% in the Asia region during the quarter, this despite the unfavorable geographic mix. Improved profitability in Indonesia and higher pricing across the region more than offset the impact of lower volumes in Japan and Korea. Importantly, our market share in Korea has sequentially improved from the second to third quarter of this year and is at a higher margin following our price increase in February 2012. Industry volume in Japan declined by 7.7% in the quarter compared to a very distorted third quarter last year when distributor and trade inventories had been replenished to ensure adequate stock levels following the event in Japan. Nevertheless, we still expect stable industry volume for the full year 2012. PMI's market share of 27.5% in the third quarter reflects a continued positive trend for Marlboro, which increased its quarterly share sequential in 2012 to 12.5%. On a September year-to-date basis, PMI's market share of 27.8% remains nearly 3 share points higher than the level before the events unfolded in Japan last year. However, we have witnessed unusually high levels of competitive product introductions, which have put pressure on our traditional brands, Lark and Philip Morris. We continue to develop our innovation pipeline and expect Marlboro's positive momentum to continue. For the full year, we are now expecting our market share to be slightly below our 2011 exit share of approximately 28%. Our leading position and our strong share momentum in Indonesia give us a unique position in the global tobacco industry. Market growth is expected to continue, driven by favorable demographics. In addition, improving consumer purchasing power is helping to drive up-trading, with the premium segment reaching a share of 27.4% in the third quarter compared to 24.9% a year ago. In the third quarter, we witnessed a decline in the low-price segment, where retail selling prices have increased at a faster rate than in other price segments. As a result, combined with the anticipated enforcement of Decree 191 by the end of November, which will eliminate a tax loophole, we expect industry volume to grow in the range of 6% to 7% for the full year 2012. Our volume increased by a further 13% in the third quarter, and market share grew by 3.3 points to 34.9%, with a particularly strong performance from premium-price Sampoerna A in the Kretek category and Marlboro in the white cigarette category. Let me conclude the Asia region with an update on plain packaging. As you know, the Australian High Court ruled in August that the plain packaging legislation does not violate the Australian Constitution and on October 5 issued its reason. In reaching a conclusion, 6 of the 7 High Court judges recognized that plain packaging deprives tobacco companies of valuable intellectual property. The conclusions of the High Court are significant for other governments considering plain packaging, as they demonstrate that plain packaging is a deprivation of property, something that we expect would raise serious questions about the legality of plain packaging legislation in other jurisdictions. The ruling turned on the specific, if not unique, nature of the Australian Constitution, which provides broad powers to the Commonwealth Parliament to make laws but contains few protections for basic rights. Australian law is violated only if the government, as the taker of property, receives a proprietary benefit from that property. Despite the fact that the property was taken, the Court found that the government did not acquire the property because it did not receive such a proprietary benefit. By contrast, the law in Europe and other countries is different. For example, in contrast to the Australian Constitution, the Constitutions of the EU Member States generally contain strong protections for fundamental rights and place limits on the powers of central governments. A finding that manufacturers have been deprived of property would, in our view, amount to a violation of a number of EU and Member State laws. Due to the scope of this specific case, the Australian High Court did not rule on whether plain packaging will reduce smoking prevalence or whether plain packaging breaches Australia's international trade and treaty obligations. The High Court ruling confirms that other ongoing international legal cases are strong and that the Australian government is at serious risk of having to pay substantial compensation in these cases or bring its plain packaging measures into conformity with international treaties or both. Three countries have already initiated proceedings against Australia before the World Trade Organization on the ground that the plain packaging legislation is contrary to Australia's obligations as a WTO member. Philip Morris Asia is suing the Australian government for multiple breaches of its bilateral investment treaty with Hong Kong. Decisions in these cases are expected within 2 to 3 years. In broad terms, these cases will examine a number of issues, including whether there is any valid evidence that plain packaging will reduce smoking rates; whether there are effective, less restrictive alternatives that Australia could have implemented instead; whether plain packaging breaches Australia's international trade and treaty obligations; and whether the Australian government will need to pay compensation to Philip Morris Asia. We believe that the international legal cases are strong, and there is still a long way to go before all the legal questions about plain packaging are fully explored and resolved. Let me now move to the Latin America and Canada regions, which had solid share momentum in the third quarter. Although volume was down, we increased our share in the key markets of Argentina, Brazil, Colombia and Mexico. Marlboro was particularly strong across the region, with share up in Brazil, Colombia and Mexico. Excluding currency, adjusted OCI increased by 10.5% in the third quarter. The EEMA region was our strongest performance -- performer in the quarter, this despite a challenging comparison. Volume grew by 3% with continued strong business momentum in Russia and Turkey, as well as an improving market climate in Egypt. Higher volumes, a favorable mix and pricing in Russia and many other markets resulted in a growth in adjusted OCI, excluding currency and acquisitions, of 17.3%. This is the sixth consecutive quarter that our volume mix has been favorable in the EEMA region. Russia was a key driver of our strong EEMA region performance, both in terms of volume and pricing. In July, we implemented a tax-driven RUB 3 per pack price increase. Along with lower revised estimates for industry volume in the first half of the year and higher prices in the market, industry volume is now expected to show a slight decline for the full year 2012. Our volume in contrast increased by 4.5% in the quarter, thanks to our good share momentum, as well as some favorable inventory adjustments. Our Nielsen market share on a quarter and year-to-date basis through the end of August was 0.7 and 0.6 points higher at 26.5% and 26.2%, respectively. Parliament, Bond Street and Next have remained the key drivers of our stronger share performance. We are also pleased that L&M's turnaround is gaining momentum, with a 0.2 share point gain in the first 2 months of the quarter. In Russia, the government approved amendments to the tax code at the end of September, including excise tax rates for the period 2013 to 2015. The government has reconfirmed the excise tax rates for cigarettes in 2013 and 2014 and extended the tax code to 2015, with an indexation of the specific excise tax set at 20%. The Duma will now review the code by mid-November, and we expect a final vote by year end. On a year-to-date September basis, Marlboro grew share in all 4 regions, benefiting from a robust pipeline of innovative products. Marlboro's share increased notably in Argentina, Germany, Indonesia, Italy, Mexico and Poland. On a worldwide basis, excluding China and the U.S.A., the brand's share increased to 9.3%. While we are pleased by Marlboro's strong performance, we are even more delighted by Parliament in the above premium segment. Parliament volume increased by 10.7% in the third quarter and by 9.4% so far this year. The brand has gained share year-to-date in 4 of its most important markets and is making inroads in newer markets. In Turkey, Parliament achieved a market share of 8.7%, representing a gain of 0.8 points August year-to-date. We continued to expand our market share in our top 30 OCI markets. Our September year-to-date share reached 37%. This is 0.4 points above our full year 2011 share and 1.5 points above our full year 2010 share. The pricing environment continues to be favorable. This is highlighted by the $505 million in pricing variance that we achieved in the third quarter and the $1.3 billion year-to-date. The combination of strong pricing, limited input cost increases and productivity savings has enabled us to continue to grow our superior adjusted OCI margin. On a PMI-wide basis, our adjusted OCI margin, excluding currency and acquisitions, reached 46.2%, a gain of 0.7 points in the first 9 months of the year. On a September year-to-date basis, our free cash flow reached $7.1 billion. Compared to the previous year, free cash flow, excluding currency, was down $1.7 billion or 18.6%. The decrease was driven by higher working capital requirements, mainly related to finished goods forestalling and the planned replenishment of tobacco leaf and clove inventories. For the full year 2012, we expect that our free cash flow, excluding currency, will be down slightly and will not adversely impact our dividend and share repurchase programs. Our confidence in the underlying strength of the business and our ability to continue to generate significant cash flow is reflected in the 10.4% increase in our dividend that was announced last month. Since the March 2008 spin-off, we have raised the dividend 5x, increasing the annualized dividend by almost 85% over the period. We spent $1.5 billion to repurchase a further 16.7 million shares in the third quarter. Since the spin-off, we have now used almost $26 billion to repurchase nearly 467 million shares at an average price of $55.49. We continue to target spending of $6 billion this year. In conclusion, the third quarter of 2012 was, as expected, a difficult quarter in terms of comparisons with last year's record third quarter. Looking at our performance year-to-date through September, we remain confident that for the full year 2012, we should be able to deliver on our 1% organic volume annual growth target, driven by strong performances in the Asia and EEMA regions. We narrowed the range of our 2012 reported diluted EPS guidance to $5.12 to $5.18. Excluding the impact of currency, a tax charge and asset impairment and exit costs, our guidance implies a growth rate of approximately 11% to 12%. Finally, we remain steadfast in our commitment to deliver superior returns to our shareholders evidenced by the fifth consecutive increase in our dividend since the spin and our $6 billion target for share repurchases this year. Thank you, and I will be happy to answer your questions.

[Operator Instructions] Our first question comes from the line of Judy Hong of Goldman Sachs.

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

Okay. Yes, I think I'll start with our previous guidance, which was $5.10 to $5.20. And if you remember at that time, this guidance included the $0.27 of unfavorable currency versus the 2011. Our new guidance assumes the $0.23 of unfavorable currency, again versus 2011. So we have a gain of $0.04 on the currency. Also, in our previous guidance, we did not have the impact of the tax charge of the $0.05 related to the closing of the U.S. tax of this and the $0.01 for the asset impairment and exit costs. So it gives me a $0.06 or gives us a $0.06 of adjustment, if you like. So if I have a $0.05 adjusted for better currency or $0.04, adjusted for the tax charge negative $0.06, I am at the -- we were at the $5.08 to $5.18, which we narrowed upward, if you like, to the $5.12, $5.18. And this should imply a growth rate on x currency basis of approximately, as we said, 11% to 12% versus the adjusted diluted EPS of $4.88 in the previous year. And I think it's clear -- it should be clear now.

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

One, for this year, would be $5.18 to $5.24. Actually, you should say $5.19 to $5.25, just not to further complicate the issue. We have the $0.01 of adjustment in the first 2 quarters of the year and the $0.01 extra of the adjustment for the [indiscernible] in the third quarter. So to be perfectly accurate, I should say it's $5.19 to $5.25.

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

That's right. That's correct.

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

I think it's partially due to the comps which we expect for the Q4 this year versus Q4 last year. We've had a very bad or very low quarter driven by some timing of the pricing tax changes in the last year. So we expect this to ease the pressure for this year. And also, we see how the end of the quarter 3, which was very low, sorry, quarter 2, which was very low for the EU, and then how quarter 3 we closed. I think this gives us the confidence that we should be in a range of 6%, even, I would say, marginally, the volumes for the total market in EU may go a little bit below 6% or let's say 6% [indiscernible].

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

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

Okay. As we said or I said in our remarks, we're very pleased with the performance of Marlboro, which not only is obviously about the level, which it had before the special situations in Japan. But also, sequentially, the quarter this year, [ph] Marlboro has a higher share. Our focus since the beginning of the year was essentially primary on Marlboro. So 4 out of 5 of the big year initiatives which we have deployed into the market were behind Marlboro, 2 behind Marlboro Ice Blast and 2 behind Marlboro Edge. The most growing or the most dynamic segment today in Japan is around menthol, super slim propositions and sometimes with the capsules -- with the menthol capsules. And this is exactly what we're pushing behind Marlboro. JT, because this I was referring mainly as the competitor deploying quite a large amount of new initiatives in the market, seems that they took a little bit of a different approach because this was broadly on the entire portfolio. So clearly, there are some brands which are more on the traditional spectrum of the consumers, and hence, the losses which we incurred in the quarter of this year are more on our traditional brands which is Lark. So Marlboro is in a very good shape. I think the innovations behind Marlboro [indiscernible] this year and what we have in the pipeline for the next year, I think we are in good shape. It's more of the fact that the focus of JT and the deploying number of innovations there and our share is a little bit below the 28% exit share. Now with regards to [indiscernible] and the Mild Seven, it's difficult for me to comment a competitor's move. It is clearly a very bold and a bright move and create some challenges presumably for JT and create, I would argue, some opportunities for others. So let's see how this thing is going to unfold in the market.

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

Okay. So on our tax in Russia, I think, first, we're very pleased that the Russian government continues with this 3-year tax outlook. I mean, we always -- I think it is good from a government perspective when they heard the news and also from the industry that large perspective to have a 3-year tax visibility, adding the 2015, clarifying what rates they would like to have, is very helpful. Now that's clearly -- there will be a substantial target increase in the 2013, '14 and '15, but something which we planned or you could say we anticipated. So I think at the end of the day, it's going to turn manageable on the tax side. On the regulatory side, I'll discuss just for us also to understand, it still needs to be approved by Duma. This is not the final thing, but this is what we know at this point in time. In terms of the regulatory, okay, they have 3 issues or the 3 subjects which they want to cover for the regulatory to understand today the cabinet approved, and they moved it now to Duma for Duma debate. There's a smoking ban for the [indiscernible] sector, the [indiscernible], which I think they target in 2015 as implementation. So it's not 2013 or 2014, it's '15. And the workplaces ban, which is 2013, i.e., next year. Then you have some restrictions on sales in the outlets below the 50 square meters. So that clearly will have some impact on our volume allocations between a trade channel and the experience from other markets is that this -- it makes it a little bit more [indiscernible] for consumers to walk a few extra 100 meters to the next shop but doesn't impact the smoking rate of consumption, as is potentially the smoking ban because if I go to the more mature market where most of the countries in the planet who have in the work who have a smoking ban, you have an impact of a 1% to 2% at the beginning of the implementation, and then the market moderated, sometimes even comes back to the previous level. So I think it is overall pretty manageable situation, but we need to assume that Russia is moving into the total market performance when you're serving a more mature country. So maybe 1%, maybe 2% part of the total industry decline.

Your next question comes from the line of David Adelman of Morgan Stanley.

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

I think you're referring mostly to Japan.

Yes, in Japan.

Okay. The Japan situation was like this. We had -- what we announced at the end of the year, we had a hurdle or what we call the hurdle in Japan, the 6.3 billion units of the equivalent, what we said, the $0.10 on EPS. And this was related to the hurdle which we had in the second quarter, mainly in the second quarter of last year, okay, due to the higher end market sales and the higher market share. What we have been confronted with in the third quarter of last year is that, obviously, following the high sales in the second quarter, we ended up with extremely low inventories of trade level. And we have to replenish this inventory to the safety level, and that's essentially when the distortions come through. And if you would do the quantification of this thing, I think that the adjustment would be the range of, say, about the 1 trillion units, okay, of Philip Morris. So you're talking about the distortions which we have to pay, i.e., we have to replenish inventories to the safety level.

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

Okay, listen, we managed to maintain, if not actually we expect that we even can slightly grow the profitability on a net currency basis this year. So yes, it is ambitious. Obviously, there was a huge effort. You see how what we believe was Marlboro and how it nicely [indiscernible] OTP segment. So obviously, we're trying to manage and mitigate the impact of the crisis. Now until you see the improvement on unemployment side very much in the south of Europe because this right here is performance of the entire EU, and I hardly can see how the situations can improve. But we are currently in a crisis, I'm talking Philip Morris, and we'll manage the situations pretty well. So unless there are any shocking type of excise increases, which we don't see today at all, I think the situation is very challenging and we all know it, but I think it's manageable.

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

Listen, already, EU should be today after the interservice consultation, okay? There was some delays before the departure of Mr. Dalli. I mean, we have learned about this new development, the sudden departure. Listen, we just hope that EU Commission will have a transparent evidence-based process while reviewing this directive, but at this stage, we do not know how the departure of Mr. Dalli will impact the timing of the strategic review. This is a development of the last couple of days.

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

Okay. There are 3 elements which are the 3 key drivers behind the working capital development this year. One is the [indiscernible] inventory, right, and that is a variable which depends on the timing and the level of the tax price changes. So that will remain but I can't give you the marketing figures because this we don't know, frankly speaking. The 2 others is the inventory of leaf, level of inventory of leaf and inventory of clove. And here, the situation is a little bit different because we had a very high level of sales also driven by Japan last year, and now the inventory has to be adjusted, okay, because we finished the inventories in 2011 at a little bit lower level because we used that leaf in our cigarettes which we sold last year. We continue with the high volume this year, and you see that we're shooting still at a 1% organic volume growth target. So we'll continue [indiscernible] inventory, which is a good thing because I'm using this to support myself. Clove is a little bit different thing because there is a cyclical clove, and this year, I have a very high clove at a much more attractive prices than the previous year. So I have no choice, actually, we're going to be doing what everyone should do, we have to buy clove once it is in the big supply, at the right prices, okay? So clove presumably may ease a little bit next year, but the rest, we'll have to see.

Your next question comes from the line of Erik Bloomquist of Berenberg Bank.

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

Okay. Erik, on the TPD, as I answered the previous question, I mean, it's hard to say today what the outcome in terms of the timing is going to be. We have not much of a visibility, what is in a draft directive. As I said, the interservice consultation should have already been at the end, and it has not started yet. So clearly, the idea of the proposal attracts the local attentions, and therefore, the draft proposal is not issued yet. So we have to just be patient and wait for this one. Moving to Philippines, yes, we had to think about the 2 points of the market share loss in the quarter in Philippines that's driven by the low price or bottom of the market. We had some pressure from, I think, one of the competitors. You know that there are some distortions due to the fact that some competitors are touching the prices, which is difficult to reconcile if somebody would pay the full excise. But I think there was a bit of a tax loophole or that sort of a nature problem. We have adjusted in some regions, I think, the price of Champion. So we're defending our position. But other than that, we're doing okay. I mean, Marlboro was up, Fortune was up. So I think that's the only problem which we have. With regards to the tax, I think the Senate just now or next week goes into recess. I don't think the Senate has yet issued or concluded with their bill, depends on how much the Senate will be different to the House of Representatives bill. They will have a bicameral conference committee when they will reconcile the differences. I think we'll wait until the end of November to have a tax visibility for Philippines.

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

Okay. So we have, I think, a further market with the joint venture where we're testing the product. We're trying to understand what is the right way of marketing that product to drive down to consumers. The whole behavioral part of this, et cetera. I think it's a mid-, long-term project. So I wouldn't go into the specifics of each individual product. It's a step-by-step learning culture from all this category.

Your next question comes from the line of John Fell of Deutsche Bank.

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

Was that correct figure.

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

Well, the fine cut growth, we said, by about 40% -- about the 40%. I think about half of the volume decline in Italy would be due to the price elasticity, and the half would be somehow almost equally distributed between the fine cut and illicit trade. We will have to zoom in into the geography in Italy because there was a lot of growth on the contraband in the south of Italy. The accounts now which last year had a contraband below 10%, and this year, they have 50%. I mean, obviously, I can throw you the names of Naples and Palermo. That is what is happening there. And also -- yes, but that's about, I think would be 1/3 of the first distribution of the losses, if you like, in income. About half is what we developed specifically, and the remaining cause in equal parts would be about illicit trade and the fine cut.

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

I would have to go -- okay, this year, I think we had March EUR 0.10, EUR 0.10 per pack, and this last year, you had September EUR 0.20 and July EUR 0.10. So I think year-on-year basis [indiscernible] to finish at the end of this quarter, you had a 4% price increase on a year-to-date basis.

And what's a pack of Marlboro now in Italy? About EUR 6?

Yes.

Yes. Okay. I can work that out later on.

EUR 5.

EUR 5. Okay. And then -- I mean, in terms of the rough breakdown of those effects illicit in OTP, are we talking something pretty similar in Spain, basically?

Yes. It's a different stage of the market because Spain is longer in the crisis, but again, you have a growth over illicit trade, I think, comparable development and the growth of the fine cut.

Your next question comes from the line of Thilo Wrede of Jefferies. Thilo Wrede - Jefferies & Company, Inc., Research Division: Jacek, can you elaborate a little bit on your views about slowdown of economies in Asia, in particular, and what impact that could have on market volume growth on up-trading versus down-trading on your ability to take pricing?

Yes, okay. I mean, I think the biggest slowdown is what I remediate in China. So for the time being, that impacts us directly. But you take -- and as you look into Indonesia, okay, there's a slowdown. I mean, they still expect the economy to grow 6%, 6.5%, highest, I think, consumer confidence, moderate inflation. So Indonesia, which is a big market for us, I don't think we have any sort of the headwinds there. Philippines, okay, we have this open tax issue, but other than that, I think the underlying economy is not doing that bad. As I said, I mean, I don't want to downplay what we read, but I think it's much more coming from China. And China, as I said, for the time being, does not have that much of an impact on us. Thilo Wrede - Jefferies & Company, Inc., Research Division: And you don't see any risk that China could spill over into other Asian emerging markets as well?

Well, I'm -- I see the forecast today. As I said, the big large market for us, Philippines, Indonesia. Okay, Japan is a different story. But even in Japan this year, following the distortions, et cetera, we estimate about a [indiscernible] market. I think we should do okay. In Indonesia, we think the market is going to grow in the range 6% to 7%. I think earlier this year, we talked about the 8%. Actually, if I look at the composition of the mix in the market, because there is a lot of up-trading, I think the value of the market grows better with a 6% to 7% volume and growth assumption that was 8%, which we had previous. So not today. I mean, today, I don't think... Thilo Wrede - Jefferies & Company, Inc., Research Division: Okay. And then in Japan, it seems like Japan Tobacco has been, for lack of a better word, out-innovating you for 2 or 3 quarters now. Do you expect JT -- at what point do you expect JT to slow down their innovations? Or at what point would you have to step up your innovations for the market?

Well, I don't think -- I wouldn't say that they're over-innovative. I mean, I think there is not that they have an innovation in terms of the benefit of offer to their smoker which is better than ours. I wouldn't say it like this. It is just the number of the launches which they did in the last 3 quarters, not on the quality, more on the quantity. I think -- listen, I'm not in the shoes of JT. I can't comment on this, and they will stop launching more products. Thilo Wrede - Jefferies & Company, Inc., Research Division: But right now, you don't see any need for you to change your innovation approach in Japan?

No. I mean, we still have -- we've just launched this week, I believe, Virginia Slims, so we know we're moving through other brands where we have a pipeline. A pipeline of initiatives is also preferred. But I think each of these initiatives has to be launched properly into the market, and we need the time to work it with the consumer. [indiscernible] crucial period of time, in the long run, it is not Philip Morris [indiscernible].

Your next question comes from the line of Chris Growe of Stifel, Nicolaus. Christopher Growe - Stifel, Nicolaus & Co., Inc., Research Division: Just had a couple of questions for you, if I could, and they're mostly just follow-ups. I want to ask you a quick follow-up on Japan which is, what's the underlying decline rate you expect for that market this year? If you said that, I missed that. I'm sorry.

No, for this year, I think we estimate the market to be flat versus last year. So I think with our estimate, the market should close at about 195 billion, 196 billion units. Christopher Growe - Stifel, Nicolaus & Co., Inc., Research Division: Okay. So therefore, the decline this quarter was not unique or different from what you expected.

No, because you had, as I said, I think there was this replenishment of inventories, which I quantified for us to be about 1 billion, and I think on the total market, the estimate would be in the range of 3 billion, the third quarter last year. So I think if you factor this in, you will come to the -- more of the normal situation. Christopher Growe - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And then I want to ask about Russia. There was a comment about some inventory movements this quarter. And then -- so just -- is there a way to quantify how much maybe that helped your shipments in the quarter? And then related to that, I know you've had a better share there. It's coming from brands other than Marlboro. And I know you have some new products behind Marlboro. So just curious if you could comment on that and just kind of the state of Marlboro in Russia.

Okay. I think the impact on the shipment was, I said, coming from inventories, but we also have a very strong share growth in Russia, okay? And this is behind all brands, not at this stage by Marlboro. Now Marlboro, we have launched ClearTaste, I mean, the extensions of Marlboro family into the ClearTaste. But I think on Marlboro, maybe I should put it like this. Marlboro is, for us, a midterm journey. We have 3 issues which we have to continue addressing with regards to the Marlboro underperformance versus our standards in Russia, one is the premiumness of Marlboro, which we're trying to correct with pricing Marlboro higher than it used to be. So the last 2 price increases, Marlboro actually took a bit more of the price increase that was the increase in the market. Second thing is Marlboro has an issue of harsh perception, and this is what we're addressing as we speak with the launch of the Marlboro ClearTaste. And the third one is the more modernity side of Marlboro, and we continue this with our marketing programs in place. I think we're making good progress, but in order to claim that we have a sustainable growth of Marlboro in Russia, I think we need to be a little bit patient. And we are patient. Christopher Growe - Stifel, Nicolaus & Co., Inc., Research Division: Okay. I have one final question for you, and that's just, in relation to the EU region, it's going to be your third year of roughly 5% to 6% declines in volume. And I guess it's difficult to predict the state of Southern Europe and some of those countries. Looking ahead, whether it be 1 year -- or 1 to 3 years, is the -- obviously, the risk in those markets where you've had this increase in illicit trade, such that you could continue to see those kind of declines in the EU region overall. I guess my question is just related to the illicit trade, if that's becoming a -- obviously, a larger and larger issue in some of these markets.

Well, listen, I mean, every single government is getting focused or has the right focus now on the illicit trade. These guys were living with the consequences of, in some countries, high tax increases in the past and also the sudden erosion of the consumer purchasing power because all these austerity measures dented what the consumer has in their pocket. I think I said in the remarks, if I look in Germany, when we see the market's doing very well, I mean, quarter 3 was pretty strong and we're still looking for the full good year of total industry volumes in Germany, I think that's partially because the illicit trade comes back at least to some extent to the legal market. So I think what we confronted today in the south of Europe, one day, this volume, at least to some extent, will come back to the fast-paced volumes, to the industry volume. But as I said, I mean, unless you see the improvement on the unemployment side, I don't think we should be betting on any sudden improvement in Europe.

Your next question comes from the line of Rogerio Fujimori of Crédit Suisse. Rogerio Fujimori - Crédit Suisse AG, Research Division: Could you just let us know if there was any news in Turkey with regards to the excise tax reform?

No. Well, the only news which we had is that, I think, the government has already increased taxes on alcohol, cigarette and some other categories. So frankly speaking, I would expect announcement of a tax increase or tax change in Turkey somewhere before the year end or at the very beginning of the next year. You know that the government have received the authorization from the Parliament to amend this specific component. This will be first time historically when Turkey would have a statutory component, but we need still see the announcement of the government. Rogerio Fujimori - Crédit Suisse AG, Research Division: Okay. And the one question about France. Could you talk a little bit about your thoughts on the outlook? I appreciate that Marlboro has been obviously impacted by crossing the EUR 6 per pack price, but any thoughts on the market would be appreciated.

Well, the market, I think, for the quarter was down about -- a little bit less than 5%, 4.5% [indiscernible] 6%. Year-to-date, I think the market is about 4.2% down. We now have the price increase of the EUR 0.40 for Marlboro went from a EUR 6.20 to EUR 6.60. But the low-priced cigarettes went from the EUR 5.70 to EUR 6. But somehow this psychological price point barrier is removed, but other prices are higher in the market. So I think Marlboro had more of the pressure being round about the EUR 6. This is somehow removed. But the whole prices are higher in the market, so we see how we deal with those. I feel about some austerity measures in France taking place and so on. So I think we need to see how that market realizes and what impact it will have. Rogerio Fujimori - Crédit Suisse AG, Research Division: That's good. And just one final question about Ukraine. I understand there was some trade inventory movements in the quarter, but I was just wondering if trading conditions in Ukraine sequentially have changed relative to the first half.

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

Your next question comes from the line of Vivien Azer of Citi.

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

Price elasticity.

Well, the market, total market, I mean, this year, I think we estimate the full year total market will actually cost 100 billion units. I think we estimate like 101 billion units. So this would represent fairly close to the 3% growth of the market. I mean, there is a price increase we took in the market. Today, I mean, the elasticities will be in a range which you've seen are replacements. If you ask me the question, how we see that same towards the tax implementation, then I need to know what is the tax which final will be implemented there. So there's a little bit of a speculation at this stage. So I don't know if we're answering the question. This year, I think the market will grow in the range of up to 3%. This is our estimate.

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

Because we're entering the fine cut, because consumers have preferences for usage of cigarette brand. I mean, there has been [indiscernible] very rapid share advancements in this category. The fine cut has a lower unit profitability than a cigarette, but it is also a [indiscernible] tax structure. The government -- some government are looking into restructuring of the tax and the fine cut, et cetera. So, I mean, it's an important element. It's becoming an important element not in terms of our profitability but overall [indiscernible] service which we're delivering to the customers. This is how we look at that thing. Part of this volume, I also think, will one day come back to the manufacture of cigarettes.

Your next question comes from the line of Chris Ferrara of Bank of America.

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

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

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

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

Your next question comes from the line of Michael Avery of CLSA.

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

Well, as far as the government focus, and it's not just the Ministry of Finance, the Customs authorities, but there's, as I understand, a number of ministries and the state agencies which finally sat together and decided to do something about it. And to their credit, they did a phenomenal job. I think the situations or the tensions in the Turkey/Syria border also helping a little bit, okay? There was obviously more intensity of the border controls, et cetera, so that's other key driver. I think the government which seems to be committed to address the issue of the contraband on the Syria border.

Okay. And then back to Russia, I know we've covered a lot of stuff here. I just want to make sure I understand exactly what you were saying. If the tax increase is approved by the Duma as it stands now and as it's written, are you saying that, that would be manageable? Or would you characterize that as a disruptive tax increase? Or just at least looking from this year to next, what's the magnitude of that, in your opinion?

Well, the magnitude of this thing in terms if it stays as it's proposed by the government now, then next year, this will translate into the platform [indiscernible] platform of, I think, RUB 6. And thereafter about RUB 9. If you take the pricing in Russia, and you take the inflation, it is an increase, it is not a minor increase. As I said, I think, a substantial but manageable. But this is not a [indiscernible] increase.

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

Well, this is a second year in a row when we have a 3-year tax visibility. So I think we did more government, not only Russia, going for that sort of an approach. I have Germany, I have other places where they want to see their 3, 4, 5 years tax outlook set that way, and that clearly demonstrates the results are a benefit for the government.

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

No. Listen, our strategy is very clear on this one. We want to commercialize this product, but with a claim. So I need the regulatory approval to allow me to say what the product which we have, one of the 3 platforms which we're working on, can provide in terms of a benefit to a consumer. So we don't want to make a shortcut on this one. I launched the product which we have but without that being able to make the claim. I think that's very important.

Your final question comes from the line of Ann Gurkin of Davenport. Ann H. Gurkin - Davenport & Company, LLC, Research Division: I wanted to ask you about pricing which year-to-date has been a strong contributor to results. And how should we think about the pricing lever for fiscal '13?

One I am afraid I can't share it with you. But, historically, if you look at since the spin -- since the spinoff, I mean, our pricing variance was in the range of $1.6 billion, $1.8 billion, and I think we don't see that much of a headwind. So pricing stays in target, and it will remain very important component of our growth model. Ann H. Gurkin - Davenport & Company, LLC, Research Division: Perfect. And then if we think about marketing spending and brand support, are there any changes in that strategy either by market or by brand as you look out the next couple of months? Anything you can comment on?

No. We continue spending. Listen, we have a great growth volume and a share momentum last year, this year and also behind the Marlboro and of our premium Parliament, and I think it's very wise to continue that spending. So we're going to continue, even in tough environment like EU or other places.

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

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

That does conclude the Philip Morris International Third Quarter 2012 Earnings Conference Call. You may now disconnect.