Philip Morris International Inc. (PM) Q3 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the Philip Morris International Third Quarter 2017 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Philip Morris International management, and the question-and-answer session. [Operator instructions] Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community. I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

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

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

Thank you. We will now conduct the question-and-answer session portion of the conference. [Operator Instructions] Our first question comes from Adam Spielman from Citigroup.

And I have a couple of questions please. First of all, you’ve obviously seen good growth in Japan, but nonetheless slower growth than you saw in Q2. And I’m talking about the market share growing 190 basis quarter-on-quarter on the IMS basis versus 290 last quarter. And I was wondering is that entirely due to the fact that you have supply constraints on the devices. Or is it perhaps because your -- now should not as you grow growing market share is harder, or is it somewhat with the competition. That would be my first question.

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

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

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

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

We have highlighted this 2 billion little bit or more than 2 billion inventory movement essentially Japan, driven in Japan. This number contains as you might have figured it out yourself contain reduction of inventories on combustibles, because the volumes are going down. And bringing the inventories of IQOS to something that you will consider the sustainable level, which the moment where we start the low thinking of device capacity, et cetera, which allow us to continue supply the market without any disturbance. It is not a typical inventory build-up, which you have ahead of the launch and later on or next period, you take adjustment for -- I do not expect that the pipeline of inventory to Japan to the normal level, which would correspond to our anticipated demand for the product would have to be reversed in 2018. So this is not a classical think, which we had traditional, conventional business that is inventory movement to the positive in a one quarter or one period, we’re resulting in a payback period, negative payback periods in the next period. I do not expect this to happen with this one. So yes, we highlighting that we shipping the product ahead of IMS or will be market sales, but we need to build this inventories operation, we cannot run to normal operations and they should stay in our base also in a base of our revenue growth for 2018.

So you're going to actually be inventory build in '18, I think as we're seeing…

We’re building inventory to the desired durations. And as you know, when your targeting duration is always the question of the forecasted future sales we know where the outlook for the demand is. And therefore, obviously, three months of inventory. For example, three months of inventory today in Japan is a much higher in absolute terms that the tree months of inventories year ago. And that obviously create optically or in fact creates the inventory moment, but essentially I'm just trying to keep the inventory, build the inventory to what we think is the right level. Taking into considerations that the product is subject to the surges in the demand much higher than any other launch new products in a conventional business, and bearing that in a mean time until we have a full capacity in other locations in Bologna that have to manage the risk of continue each of supplying the market.

Our next question comes from Judy Hong with Goldman Sachs.

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

Purely on a pricing front, the biggest surprise to the negative unfortunately came from Russia. Like all the pricing for that launch in a year, net pricing, net manufacturers’ pricing just readily passing the January talks, came as a surprise. And due to the size of the market and our position in that market that clearly put their big pressure on our numbers. And I have to admit at the beginning of the year we knew that the pricing is getting a bit -- not as we already expect, but I admit that at the beginning of the year, we didn’t talk that it's going to last for deadlock. If you want to see a rainbow, maybe you will have to go for the rain. So I was saying it’s presumably should go well for the 2018 because the prices are moving slowly in Russia, so at least '18 should look much better versus ’17 as we have now. But Russia was clearly the only market on the pricing, which got reached took us by to the negative place to price. If I look at the German and a few other markets, if you’re referring to some delay in price increases et cetera, Judy, it was always like this. So this is not that I'm happy about it, but it's not something which is surprising. I have seen it -- so it’s a little bit of the normalcy in there. And then obviously this whole GCC in Saudi Arabia, in particular in the quarter, which is a mix of the prices went up so the industry platform is very heavy, very high target increase. But the market is reacting as is reacting to the 100% price increase. I think and many investors have underestimated or underappreciated the size of the GCC in terms of the volume, but also profitability. Saudi 2016 was a market of, if I remember correctly, around 32 billion units. PMI Philip Morris has about 41% share, Marlboro is half of 28%, actually more than a half of that is Marlboro there. Margins and this is where that you will see it -- margins in Saudi available of PMI average margins and clearly Marlboro is well above the Marlboro average PMI margins. And the market goes at least at this stage by 30 or more than 30% down that starts putting quite a significant pressure on our financial. I have to say it like this. We have, both at the beginning of the year this guidance of 9% to 12% EPS growth, and I know today that if not Saudi and Russia we would be flying well above 12%, well above 12%. Knowing what has happened to IQOS, which comes very strongly. If I wouldn’t have a Saudi and Russia we would be flying well above 12%.

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

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

Can you quantify how much?

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

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

Well, we’re always weighing the opinion that the product whereas the different tax treatment in the combustible classical cigarettes. So, on a one hand yes I mean in Korea tries to move the tax up. I think they are recognizing that the product should have, should enjoy the different taxations than a combustible. So we’ll see where we lag. The decision is not final. But my understanding is that the product will have a real enjoy if you like a lower taxation with combustibles, which taking into consideration, the risk profile et cetera of this product is absolutely understandable from any aspects, public policy smokers, et cetera. So as you know in some countries, the tax differential is very attractive on RRPs or IQOS versus combustibles. I don’t think in a long, long term that level of a tax differential will be maintained, if stays perfect. But I do think that there will be -- that this product will enjoy a lower taxation within the conventional cigarette. Remember also is the growing understanding of a harm reducing principals, in which the product innovation plays the important role. Even the most recent FDA announcements squarely fit into this direction. And I would assume that the tax policies, as many other regulatory policies, will do differentiate both categories to the benefit of the reduced risk policy.

Our next question comes from Vivien Azer with Cowen.

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

Well, if Russia pricing environment would improve faster or earlier, essentially would be squarely in our 9 to 12 or in the -- or then has to go to the 9 to 10. The Russia alone would clearly -- or shorter duration of this price situations in Russia is like, would keep us in the upper end of the guidance. I said before that GCC in Russia is this wouldn’t have happened this year, but would be well above 12%. I don’t want to quantify this one, but I'm not talking 10 or 20 basis points, we will be flying about 12%. Assuming that IQOS obviously stays as is, which is coming strongly -- is coming very strongly. So as I said, it’s very handy on the one hand that we have this great performance of IQOS, and it is coming at the moment when we have to somehow mitigate financially, if you like, the pressures which will have this year in Russia and Saudi. Saudi will continue at least from the annualization perspective for that next year. We’ll have to see where the markets stabilize. They have some other part of the GCC of the Gulf operation council countries to change excise, the way it’s changing now in October. But Saudi alone is a 65% and profitability is even more. So I think the biggest identified impact and a drag we already have there.

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

It’s just Russia is I would add to it normally would have, which should have been, if you like, there is a level of pricing in Russia now. Our pricing variance would be squarely in what we’re always saying, 6% and 6.5% actually. So that’s presumably we know that we are now below 6% and still pretty stronger price realization, is just the missing component of Russia. I mean it's all our countries. There are countries, which in effectiveness of a tax structure et cetera pricing is always a bit of a questionable, because it’s a big trade of between volumes and pricing, like Italy and France, for example. But there’s other -- the no known type of a market. Other than that, yes, I mean there were some delays in pricing in Germany. Frankly speaking, every time when we have over the last few years, has been taking prices in Germany they were always delays. So as I said earlier, it's not that it makes me happy but this is not surprising. I mean Russia I don’t think anybody achieved the success in Russia with what has happened in Russia is positive.

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

No, I don’t think we lost the share in any of this place. The only place which we have highlighted, which is going -- which has a growth but this is a very -- comparative other others small growth is Spain. But that’s a different thing. But Germany -- I mean Q3 the numbers were 0.6 for the quarter, 0.4 quarter before. So remember that we do not present really in Germany, we presented in a few cities, so the focus is there. I’ve been recently in Munich and I think the thing start working slowly. Germany is not -- I don’t want to offend anybody, not a fastest market in the world. They produce the fast, but things takes time in Germany. Therefore, I'm very much looking somewhere in euro that I can focus more on markets like Germany and others.

Our next question comes from Matthew Grainger with Morgan Stanley.

So if I could go back to just to heated tobacco category in Japan, generally, as you talked a lot of device constraints and some of the limiting impacts that maybe having in the short-term on progression of market share, which regardless is still very good. Could you -- I know this is a difficult topic to elaborate on. But could you give us any observations you have about the interaction between IQOS and competitive products that are launching in the market? I think it's clear that it hasn’t stopped your progression, but I’m sure that consumers want to sample the various products that come out. Are you getting meaningful observations from consumer who are using IQOS and one of the peer products? And then making that decision, potentially using them in a dual manner or switching back to IQOS fully? Just in any context you can share on that?

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

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

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

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

Thank you.

Our next question comes from Michael Lavery with Piper Jaffray.

I was just wondering if you could elaborate a little bit on some of your thinking on IQOS spending. Has that increased? And specifically, I’m curious if that’s part of the guidance adjustment? Or since you held your revenue guidance for same, is it just your guidance is maybe -- it doesn’t have an upper end, it’s open ended. So, is it just that you’re closer to 7% than you were previously? Or is it that you've kept the revenue guidance, seen the weakness in Russia and Saudi Arabia, but you’ve got an offset somewhere else that’s lower margin. What’s the right way to reconcile all those pieces?

Well, definitely we’ll deliver revenue about 7%, and the upper end of the guidance always is on the revenues alike. It’s always a factor how many devices we’ll be able to ship and how many HeatSticks we’ll be able to ship et cetera. I think we have a good view now on what's going to happen to the volumes and the price in Russia GCC et cetera. So it’s just on this one. Remember I think was a quarter or two quarters ago, I said that we're approaching a time when we have up 7% in revenue and I do hope and actually I think it will become a new norm for PMI. So as a mix of the volume growth and the pricing growth, I think is a good quality top line growth, which the Company is capable, is able to offer now. And obviously, we’ll be may be much higher that seven in this quarter was -- you could see the quarter revenue growth even if I was to be very aggressive and adjust the entire revenue growth by the growth, by contribution of devices, which as I said earlier answering one of the questions are drag on the margins, at least at this stage. I still would be well above our past target, if you like the 4% to 6%. The thing we approaching with PMI at the time this type of top line growth should become a -- not necessary on quarters, as you know very well, we never manage the business quarter-to-quarter, we focus in the longer period of time. But I think this is what we can, when we can deliver what we can achieve.

And just on IQOS marketing investment spend piece of it. Is that incrementally a higher number or is that -- are your plans there pretty much the same as they were and it’s just the…

Higher than last year, obviously, we're not increasing versus what we've planned for this year. We’re just implementing the plans. There is this variable component, as I mentioned earlier. We've seen that investment, one should also count that the devices if you like or some loss on the devices and that’s a variable component because consumers decides to buy more devices than one per person and obviously, somehow increases the investment. But as I said, we're working for the pricing in our schemes will address it. But on the other hand, we're essentially -- we have first manifestation of the loyalty of the consumers, because while consumers will buy will purchase more than one device if they are not sure to stay with that product within a category. So I would read it very positively for the future periods. And that’s -- this means that we have a consumer and the consumer is happy with the proposition. As you know, we're rolling out new versions of the devices. I think this will become a norm that every period or so, there will be additional devices. There was a growing demand for accessories for the personalization, et cetera. I think that Japan obviously will be on the forefront because there is a larger at this stage consumer groups to serve. So there will be other revenue and hopefully also margin from the big opportunities which are ahead of us. So the things which are coming a little bit faster than expected and may put some pressure, again this multiple device ownership this year with the negative margin finally. And we take a bit of a pressure, but I think it's very good for the next period.

And just back on -- you've touched on how you have been able to get enough capacity to stop building the inventory in Japan, and save on the air freight. But do you still expect to be capacity constrained through this year? And if so, obviously, then that would mean…

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

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

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

Well, Indonesia specifically where big part of distributor and…

Okay. But I don’t think that -- well, I am not saying acquisition. I'm just saying that I don’t think it's going to drastically change the dynamic in Indonesia. Philippines yes, actually so the positive happens to be also JP. So my focus in more on the Philippines than in JP and Indonesia.

Our next question comes from Bonnie Herzog with Wells Fargo.

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

Because not in all markets we can say what we know about IQOS and what I think we should say to consumers that they have an access to the full information what this program does versus combustible cigarette. As you know, these regulations -- regulation is always a somehow retroactive, if you think, if you like in a sense that it’s difficult to regulate the things, which are not in the market. They are in the market and then a regulators start thinking what to do. So we’re not operating in the regimes where it’s clear we recognize that this is a heated versus combustible tobacco product. And therefore we can make X, Y, Z type of claims. So we have to somehow adjust to the local market regulations conditions, et cetera. We know very well that consumers could switch to IQOS, who adopt the IQOS, pretty quickly and they experienced. If they fully switch out of the conventional cigarette, they’ll realize the benefit of switching to the product. I mean the symptoms, which they experience, are very much similar to those who have quit smoking, so they all positive. So this is the word of mouth consumers talked about the things, but this obviously takes a bit more time. The second thing is that in different markets, you have a different marketing channel still open, being the communication channels where I can advertise when I can talk to consumers, et cetera. Some markets we only -- I give it a example of Germany. In Germany, we can use outdoor but very few things we can say on this outdoors by regulations. So I think there will be some development soon. But for a time being, we are little bit restricted. In Italy, theoretically, we can say more things or practically we can say more things. But I don’t have outdoor or print and we essentially restricted to the communications in the tobacco. The tobacco this is nothing else than the convenience store when the people are coming for 20-30 seconds transaction time. So all of this markets each of them has a different type of challenges and we have to adjust our structures and infrastructure in this market to take the battle. And as I said earlier, essentially with the consumer one-by-one knowing that there is consumer number X, which will be a tipping point and then the whole thing will create a snowball effect, which we have created in Japan or very fast actually in Korea.

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

The new variant, the menthol with the flavor, I mean it was very well received. As we producing -- we're shipping what we’re selling was we produced. So is also behind. There is obviously some, if you like, internal cannibalizations and now in the presence of more variance consumer are switching from other variants. Variant is responding that face variant is responding through some taste preferences, which were existing or exist in a combustible business. So we will try in some markets to -- there was an important segment in terms of taste segment preferences, we’ll try to cater to this need. But so far is essentially Japan. And with regards to pricing in Japan, well you know the history, right. We tried we ended up with a Marlboro price increase. And I guess for the New Year time, it’s going to stay unless there are some changes around the taxations in Japan. But I think for the long -- for the first time in a long history PMI in Japan, we’re frankly speaking Japan is missing nothing in terms of generating the growth of OCI in a current situation. Thanks to the fabulous volume performance. We’re frankly speaking and we have a phenomenal OCI growth in Japan and somehow pricing. If it comes it would be nice cherry on the cake. We obviously know our positions on the pricing in the market. But what was always the bottleneck in Japan that you cannot grow the market without the pricing. We actually found the solution that you can grow the profitability in the market absent the pricing, which normally should have happened but it’s not taking place.

Our next question comes from Chris Growe with Stifel.

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

Platform probably start in the second -- platform will go to the test market this year, but we still have not announced where we're going to do it. The 60 billion or about 60 billion is a year-end annualized capacity. So with nothing on the capacity for next year, which obviously is not the plan, 60 billion plus we already have in pocket. And obviously we adding the machinery and then activating the other factories in just Italy. We actually have the first shipment from production and shipment from Romania factory. So, I mean it goes as per planned. So as I said, we’ll update on the capacity in February. So there’s capacity, remember initially we targeted 100 billion year end 2018. And because now we will start the year with a higher capacity is obviously logical that the year-end installed capacity 2018 already will be lifted at least proportional.

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

You will have the markets well I mean -- in all of this market, we always balance where is the right moment when we want to go national. And we tried to build a much bigger larger IQOS communities within a territory. And therefore as I said very often this national market share are not really reflecting the pockets in which we focus. And we have places in Italy, in Switzerland, in Germany, where locally if you like markets are 2%, 3%, 4%, 5% depends on the location. But this is how we want to build the whole thing before we start spreading the results is to thinly around -- across the broader geographies. If you look at the markets also, we started already some developing market, which is also very important in our strategy. I think on the chart we had Colombia, which came to the 1.4% market share in Q3, very strong start. So we will be in a number of geographies, trying to either open the market for the first time is was is starting with a one city, two city capital cities. And in cities where the market where we already presented with some cities to assess where which markets, we think this markets and already for the national expansions, taking into consideration also availability of the marketing channels, et cetera. So how labor and capital is like intensive, this might be for us to the next year. But I think what we have created through to 2017 is a very nice base of a market to select from for 2018 expansion plans. So I think this was our objective. And some markets may go full speed 2018, some will go 2019. We have now the luxury, if you like, of a choosing how we want to push the pedal there.

And then just a quick follow up on your total cost in the quarter, constant currency were up pretty strongly by our estimate. Does that -- do you think that they will continue in the fourth quarter? And should that continue into 2018 as you consider more of these launches, and just more investment behind IQOS, in particular?

There is investment behind IQOS remembering the total cost, you also have just the impact of IOQS, right. So on a purely COGS, due to cost on the COGS, due to cost. The cost will be flat, very marginally different, due to COGS. Now, if you take the volume impact, you will have a positive on combustibles because we produce less and you have a negative, if you like, on IQOS because we produce more. And actually that negative on IQOS offsets the positive on a convention.

Our next question comes from Jon Leinster with Berenberg.

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

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

Assuming Philippine volume up, Australia volumes down?

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

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

On the HeatSticks side in the third quarter?

Well, it’s the same as you’re basically constrained by volumes, and you are saying that the constraint is on the device side. Does that therefore mean that you could have done well above just under 10 billion units?

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

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

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

Just to be clear, if the capacity -- if P2 on the secondary side, can you see traditional conventional machines to produce the stick on the P2?

No, the machinery line is different. We always were saying the concept of putting few components together and formula route, which is a cigarette or the HeatSticks is the same. Therefore, we’re trying to -- our objective is to do it as much as possible within existing facilities because we can use our people and the scale. And therefore, the learning curve is heavily picking up, but machine wise or CapEx wise, if you like, this will require a separate program, separate investment.

So, P2 picks up. We can expect another build out of capacity in different build out capacity?

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

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

This is Philip Morris International Inc who take the full benefit of…

At the lower cost. Okay, fine…

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

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

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

Ladies and gentlemen, we have time for one more question. Our final question today will come from the line of Owen Bennett with Jefferies.

Hi guys. My questions has been asked. Thanks.

Okay, have a good day.

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

Ladies and gentlemen, thank you for joining the Philip Morris International's third quarter 2017 conference call. You may now disconnect your lines, and have a wonderful day.