Good day, and welcome to the Philip Morris International First Quarter 2017 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] 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 first quarter results and 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 first 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 now reflect cigarettes PMI’s heated tobacco units for those markets that have commercial sales of iQOS. A glossary of terms, adjustments, and other calculations, as well as reconciliations to the most directly comparable U.S. GAAP measures are at the end of today's webcast slides which are posted on our website. Reduced-Risk Products or RRPs is the term we use to refer to products that present, are likely to present, or have the potential to present less risk of harm to smokers who switch to these products versus continued smoking. Today's remarks contain forward-looking statements and projections of future results, and I direct your attention to the forward-looking and cautionary statements disclosure in today's presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. It's now my pleasure to introduce Jacek Olczak, our Chief Financial Officer.

Thank you, Nick, and welcome ladies and gentlemen. As announced this morning while increasing our 2017 reported diluted EPS guidance at prevailing exchange rate for $0.04 to a range of 484 to $4.99 for a favorable tax item only. Our guidance continues to include $0.08 of unfavorable currency. Excluding currency and the tax item our guidance represents a growth rate of approximately 9% to 12 % compared to our adjusted diluted EPS of $4.48 in 2016. AS a reminder, we expect that our currency neutral financial growth to be skewed towards the second half of 2017 notably reflecting increased heated tobacco unit capacity and improving returns on our RRP investments as the year unfolds. Let me now thank you for our first quarter results beginning with our combined cigarette and heated tobacco unit shipment volume which declined by 9.4 or 7.8% excluding estimated inventory movement. The decline was due primary to the impact of lower cigarette industry volume partly reflecting the micro-economic environment in Indonesia, Pakistan, Philippines and Russia as well as the high prevalence of illicit trade in Pakistan and Philippines. As seen on the left side of the slide over half of the total decline consisted of low price segment volume some of which contributed very little, if any, unit margin. This limited the impact on our profitability and differs dramatically from the overall price segment split of our premium position portfolio as shown on the right. Our first quarter volume decline was slightly larger than anticipated due to essentially to the lower industry volume in Pakistan and Philippines as well as the magnitude of unfavorable inventory movements in Italy and Spain. For the full year, we expect a combined decline of 3% to 4% broadly in line with last year. The expected improvement over the balance of…

Thank you. We will now conduct the question-and-answer portion of the conference. [Operator instructions]. Our first question comes from Chris Growe with Stifel.

Hi.

Hi, Chris. Good morning.

Hi Jacek. How are you? Thank you. I just want to ask you two questions if I could. I just want to get a sense of you have this IQOS available in 24 markets today, there has been some comments saying it's going to go into France and there is more markets still to come throughout the year. As you look at your capacity development throughout the year, you've given the numbers clearly what's available for the year, but you're having a pretty quick uptake obviously in Japan I mean you need more and more volume for that market. I just want to get a sense of is it more important now to have this available in more markets or to make it more widely available in the existing markets in which you're in, do you have the capacity to do both of those in 2017?

Okay, it look it takes a bit of time in each market to build necessary capacity infrastructure in order for the national expansion. So, I mean what we have learned so far from experience we have with the commercialization of IQOS is that that is the start always with one or two cities and start building the expansion based on what we had been learned and what we have installed in these cities. This requires quite significant employment of additional sales force but also creation establishment of IQOS stores, boutiques, Brexit stores etcetera. So, we always will need that runway and essentially opening in these markets earlier does not put at this stage that much of a constrain on available capacity but allows us to build faster much broader ways ahead of 2018 or 2019. So this is how we look at this thing. And as you might have noticed Chris, we also have making now the decision to take this theoretical capacity expansion of a 4 billion per month which we have announced half a year ago that we have that option, we have decided to essentially implement this plan. So, we already committing ourselves to this 100 billion year-end capacity next year to essentially accelerating our plans.

Okay. And do you still expect IQOS to achieve break-even probability in 2017?

Absolutely.

Okay and one quick one if I could on the volume performance for the underlying business and it was obviously weaker than we thought obviously weaker than with the new thought. And there is obviously some adjustments from inventory and timing changes and you gave some color around that but going forward, you'd expect a pretty significant improvement in the underlying volume performance of the business. I just want to get a sense of, so we look across a lot of the markets is there some pretty significant market share declines in some markets, do those start to narrow or is it more about IQOS developing and contributing to your overall volume? I just want get a sense of that balance you expect for the rest of the year.

Look, I mean at some markets when we have posted in the quarter some more sizable market share loses, we have highlighted in my remarks and in my remarks the sequential development. So, in both markets we can see the improvements Q1 and Q4 or the sequential within a quarter etcetera. So, I think we keep that strong grip on the conventional business in the market where we for whatever reasons under pressure. I mean Italy is a little bit more complicated because on the one hand we were focusing on a combustible business while also building the base for the IQOS. But there are some problems in Italy which frankly speaking beyond our power to execute as we noted the tax structuring in Italy is not very supporting for narrowing the price gaps, Marlboro is above the Marlboro in a conventional business, on a conventional cigarette, is above the €5 price point. So, I guess there will be some pressure on Italy on Marlboro in Italy in a conventional business continuing for the year. But on the other hand, Germany still continues to be on the strong term, France despite the fact that we have a first quarter, I know it’s bit early of the plain pack implementation but France posted very good results in a quarter. And the rest is purely the comps. Remember that we are comparing the first quarter to the relatively strong, weaker declines in Q1 of the first quarter last year in Argentina and then we had this in the last year for tax increase. The others, number of average geographies but we also faced a bit of most challenging comps in the Q1. What came if I may ask is what came as worse than our expectations frankly speaking is Italy and Spain…

Okay. That was very good color. Thanks for your time.

Thank you.

Our next question comes from Vivien Azer with the Cowen.

Hi, good morning.

Good morning, Vivian.

So, just to follow up on Chris's question. So, if we're still looking to break even in '17 Jacek, given the momentum that the business is seeing, year on balance it would seem that you're still on track to generate incremental profits from IQOS in 2018 but how are you thinking about the need for reinvestment spending given your first mover advantage in the traction that you're seeing from the product and would you be able to offer any kind of order of magnitude guidance around what that level of profitability might look like? Thanks.

Look, we have said it I guess earlier this year that we look and we can reconfirm this here from this today, we are looking at the revenue growth above 6% and earlier we have said that we are still looking at the margin, operating profit margin expansion somewhere in the tune of 10 to 20 points. Clearly we could say that to achieve that better margin expansion but it is not factored in increase investments namely behind the IQOS. This is both on the OpEx and operating cost and I announced as we announced today also on the CapEx to prepare the capacity. So, I think we well invested frankly speaking on the both sides both on a combustible, although there is some reallocation or allocation of the resources from a combustible business to reduce these product but I think we feel that pretty comfortable with the investment which we plan to make this year as I said to support the revenue growth above 6%.

That's helpful and just in terms of the longer term outlook for 2020, Olczak, you would point it to a higher profit number when you spoke at the Cage Conference. So, can you just offer a little bit contexts on what the implied HeatSticks volumes would be for that 1.4 billion to 1.5 billion an incremental profit? Thanks.

Yes, a number of times recently I'm being confronted with this question, Vivian. Yes, we gave that outlook I guess three years ago or so. And I have already admitted, maybe I shouldn’t, I have admitted I think at the Cage Conference a few weeks ago both numbers seems to be wrong. Either 2020 was wrong and we are going to keep the target well ahead of this deadline or definitely the volume number was wrong. I mean, you could at the pace which we are cruising today, we see the penetrations in the markets are in Japan; it goes well above the 3% to 5% which we have marked the target for 2020. So, you have to give us the time to really put our brace around what really the size of that opportunity today. Clearly, it's a much bigger opportunity that we have felt two years ago but they would refrain from giving a new target at this stage. We have also said to investors that in 2018, somewhere in 2018 we'll try to come up with a new improved vapor for PMI and I guess this would be the best timing to put some milestones what we want to achieve with our big objective to go to this smoke-free future as PMI.

That's helpful. Thank you very much.

Our next question comes from Judy Hong with Goldman Sachs.

Thank you, good morning.

Good morning, Judy.

So, first in Japan, so there's been some press reports about PM planning to take some pricing on your combustible business. So, can you confirm whether you file for price increase application in Japan and combustibles?

Judy, you will appreciate but I can’t comment on our future pricing decisions, at least at this stage. So, we will have to leave it as it is now.

But when you kind of think about your full year guidance at this point, does that include any of the potential price increase in Japan?

Judy, please I can’t comment on our future pricing.

That’s fine. Alright. And then I guess staying in Japan, so obviously you've seen a pretty strong share gains even in Sendai as your competitor have launched in that market. So, how do you sort of look at that market and kind of what are the lessons learned in looking at that market and applying kind of a similar share performance to the broader Japanese market or your ability to kind of defend your share as your competitors begin to expand more nationally in Japan?

Look, we just look at Sendai and maybe the data is not fully reliable for us and for our competitors. They are our competitors there but I think in Sendai in the quarter, the total heat-not-burn category must have crossed 20% market share. What I hear, what I know from our side and what I hear about our competitor without operating with some sort of a capacity limitation and I know that they are quite awaiting in Sendai and other places in Japan to buy IQOS or competitors device, which tells me that demand today is 20% and is growing and it has a large portion of unsatisfied demand. The people are not allowed to buy devices because the devices are not available. I wouldn’t be surprised if Sendai category and heat-not-burn category in Sendai would cross the 30% share of total market by the yearend and may be even that number is wrong. I think we clearly can see the word of mouth in fact that people have been adults who have successfully managed to quit smoking and have moved to heat-not-burn category and sharing the benefit with the peers, with their colleagues etcetera. So, it’s a classical word of mouth type of an effect. Category is gaining awareness both in terms of its existence and the benefit that category work for us. So, it's our long goals for the great future but I think is a big question now what is really the how long that growth rates are going to be there and what is the ultimate size of that thing. Is it a 100% of the market? I guess, no but people, this is you remember me saying on number of occasions, this is not the most innovative industry if you look at the history of this industry, right. The filter cigarette, the filter bud and that's about it. And then little bit about the capsules and a three or four months. It still get a while to convert cigarettes, conventional cigarettes from a non-filter to filter cigarette. But it happen in a less than in about five years 10 years depends on the market. Maybe, we in a front of such opportunity here, we'll have to see. I mean, it's all goes into the right direction. Obviously, Japan is a little bit in a better situation due to the marketing channels availability compared to our markets etcetera. But even if we start factoring this in, you may just this feel to the on a timeline of the curve, the difference of a one or two years but since that the product might have -- there are consumer sizeable group of consumers, very sizeable group of consumers who are waiting for that one.

Okay, got it. And then just lastly on the capacity related question. So, with the €300 million investment that you've talked about for the Greece plan, that gives you 20 billion additional fixed from an IQOS HeatSticks perspective. So, that would be 50 billion plus 20 billion, 70 billion. So, would there be incremental CapEx if you were to get to a 100 billion capacity by end of 2018 and should we take that into consideration just from a CapEx for a '18 perspective?

Well, there won't be impact on the CapEx in '18. We have not announced the number of the CapEx for '18. So, we have to wait a bit, till the thing which we have. The Greek numbers, which your or number for the Greece conversion, Greek factory conversion is included in my 1.6 for this year as CapEx impact on the cash flow. And then I guess we will have other factory conversions, the capacity expansion capacities, which we'll be announcing as the year unfolds, in order to build up that 100 billion. Okay, because always is the question of the machinery and equipment and is obviously the questions where we're going to host and when we're going to locate that manufacturing capacity; especially we're thinking in a context of converting existing combustible assets.

Alright, okay, thank you.

Thank you.

Our next question comes from Bonnie Herzog with Wells Fargo.

Hi, Olczak.

Hi, Bonnie.

Hi. I have a couple of quick questions on IQOS. Could you give us an update of from your test for platform two? I believe you were testing that in the first quarter and if so could you again give us an update on how that performed and any plans to roll that out?

Bonnie, we remember, kept on these two many occasions. We haven’t test platform two in the first quarter. We have said we're going to test it later this year.

Okay.

We have P3 and the P4 as well in some cities or in some locations. But we have not done this test yet.

Okay. So, it's on task then to be tested this year still.

Oh, right.

Okay. And then question on your tax benefit for IQOS. I guess I'd like to better understand these tax benefits in the market share and so on average are you still seeing around a 20% benefit across all of these markets and then curious, what are the economics on IQOS in markets where there is no tax benefit. Could you still generate profits on IQOS that would be comparable to your combustible cig business?

To my, first to think the IQOS lower talks on heat-not-burn category is by the first country-by-country but it would be better or a higher benefit than a 20%. I guess, Japan is in about plus/minus 20% benefit. That's one. Second is, from my knowledge, frankly speaking, I don’t recall a country in which we have commercialized about frankly speaking to commercialize in which the heat-not-burn category is not classified as a lower with a lower tax benefit.

Alright.

I might be wrong, but I don’t think so we have any single country to their market today, when we wouldn’t have the when heat-not-burn wouldn’t have a lower tax classification.

That's what I thought, Olczak. But what about a scenario where fast-forward several years where some of these governments might change the tax benefits which we can argue why that should be the case. But just let's think about a worst case scenario. So, I guess I'm trying to get a sense of in the economics on IQOS if you had no tax benefit. There must, help us understand that and how you think about that.

Okay. Well, IQOS saw the HeatSticks are sold at a price of a premium segment, right, on the mark.

Right.

So, that’s even excluding the tax benefit, we are premiumizing our portfolio and we're operating with the positive mix product mix category territory. Secondly, as we roll out and build up the capacity, we also are gradually lowering the cost of the manufacturing. So, as we have said from the very beginning of our journey in this new category, we would one should expect that one day the consumerable the HeatSticks will be manufactured at the very close unit cost to the conventional cigarette. So, I have a cost approaching the conventional cigarette and I am operating at the margin level of the premium segment. So, would be equal if I would have a rapid expansion of the Marlboro volumes across the geographies. So, at least from a mix perspective, I am better off. At this margins clearly market-by-market are better than my other profit margins or unit margins on my entire portfolio.

Okay, that's helpful. Okay, and then just a last quick question, certainly your conversion rates with IQOS and HeatSticks has been very high, which is great, but I'm curious to hear about trial. How is that been building in some of your IQOS markets in terms of just essentially recruiting new users to try this technology?

Well, okay, I mean Japan is clear that the trial is frankly speaking limited because it build the factor of how many devices we allow the trade to sell. So, this trial is -- the number doesn't exist in a sense. I mean, there are the line of people a waiting list for the devices in many shelfs. So, the trial is people are buying and getting the device. In other markets, frankly speaking the trial rates are about the same as we had mid-term in Japan. In a sense, when we went to from a 60% coverage to the national expansions, you remember we have lifted the trial rates and we have lifted the conversion rates and all of the markets and most of the market where we are now with like or say enjoying about the same at the same statistics and the same leading KPI view if you like. Remember that the trial, that the product which we selling other our selloff through our selected trade partners is only for adult smokers. Right. So, we don’t have that much interest if at all from the non-smokers but by the other all the roles of conversion, the product is only allowed to be sold to adult. It's obvious because it's a tobacco nicotine containing product but also only to the smokers. And that's also important for us that we don’t create an unintended consequences of when it comes to people who successfully quit smoking or people who never smoked before.

Right, okay. Thank you.

Thank you.

Our next question comes from Adam Spielman with Citi.

Thank you. So, I'm a little bit confused about your attitude towards market share in the conventional business. When I look at the sequential market share, so I'm looking at the market share you place in Q1 versus what you placed in Q4. Outside Europe, you've seen declines in pretty much every geography that you've list in the press release. As in my question, but which is worrying to me, the listeners who've attended your prepared remarks, you imply that this is roughly in line with expectations are not a big concern. So, am I wrong to read that there has been a decline sequentially since 4Q outside Europe? And my how concerned are you about the market share trends in conventional?

Adam, I very gladly has to unconfuse you.

Thank you.

We will have to go geography-by-geography and how we look at this trends. If I take the significant market share erosions which we observed, one obvious comes for example, Philippines; very sizeable market and we have a total significant share losses and it obviously waits on a total PMI of volume and a share performance. But we have highlighted very much that instead of protecting low margin volumes in absence of the proper law enforcement when it comes to compliance with regards to the tax takers, we just about two years ago changed the strategy and what goes on managing the more growth, the price reduction of the price gap and so far the strategy is very successful. Marlboro grows significant market share despite the fact that there is some down trading in the market. And secondly, we in a double-digit bottom digit, bottom line policy either of territory. Then you have some markets where the trends okay Indonesia is as we know is the continuous shift between the hand roll to machine made etcetera. I mean, that in the recent launches which we have made in the machine made segment including the Marlboro Black kretek, which quarter in a market and not in a full even distribution has achieved the very strong 1% market share. So, that by Indonesian standard is very strong. And also both the initiatives etcetera. I think so far there goes well. While we grow the markets share Indonesia, I mean, that remains to be seen. Can flood the market share, I feel as well positive about this one. That that's the large markets, we done a short fluctuations of share erosions matter for PMI. Then you have the market which you have typical sort of a Q1 distortion which are driven by the price…

And just with, first of all thank you because you have. And second of all just to sort of throw the comments forward. You say that in the full-year even I expect to see -3% and -4% volume declines on a total basis. My guess is that's going to be how can we put it. It is going to be somewhat weak in the second quarter and gradually improved to that -3% to -4% both I'm guessing is conventional business is less paired and as the HeatSticks picks up. Is that how we should think about it sequentially?

We should have, well, maybe I'll turn it to the other. And I think as of Q2, we should expect a much more robust revenue growth which is a combination of a pricing better volume makes which frankly speaking we didn’t talk about the mix plus a 50 in the quarter by mixing the Q1 much better or much lower than the mixing in the Q1 last year. So some of the – as I said as of Q2 we should see much stronger volume sort of revenue growth on the rate to as I said to achieve that of 6% for the full year net of currency revenue growth.

And can I ask if a very quick follow up somewhat technical question. when you quote Q6 market share in Europe I’m thinking about in Italy and Switzerland for example, is this off-take market share or is this shipment market share?

This will be off take market share. It depends on the market we state are available but we usually refer to what we call market sales, so it’s not asked to the distributor but is distributor sales. It may not in our markets be of the retail but to retail now depends.

I understand, thank you very much.

Our next question comes from Michael Lavery with Piper Jeffery.

Good morning. Just a question on – it looks like your volumes from fourth quarter to first quarter grew by around 20%, but your revenues by more like 2016/17 can you just touch on what’s driving that acceleration and what’s giving them the mix lift. Is it countries, growth now in countries with a bigger tax benefits, or is it more, is it driven by more devices outside Japan, what’s happening on the margin there?

There could be some distortion from the devices, but as we said for the full year 16, when we’re announcing full year results, I mean, roughly, devices in the RRPs related revenues should account for about 20, 22% somewhere in this range. So it might have a bit of higher shipment of the devices. But I wouldn’t look at this purely from the quarterly perspective because there are different services obviously applies and we’ve to start shipping more devices in order to follow this order to higher shipments of the heat sticks. So you’ll always will some distortion there. On the IMS basins and maybe go back to appropriate question before, on IMS basis by recall the shipments of, at least in Japan, sorry, an IMS basin the sales, in Japan, quarter-on-quarter grew about 30% and then what we see is about, if there is any distortions in the revenues presumably more from other location and devices.

Okay that’s helpful. And then just looking at Japan even on unadjusted for inventory movement basis and more so when adjusted taking at the cigarettes and the heat stick volume together at the category level it looks like there is positive growth, which is clearly better than historically it’s been, are you seeing increased use educations or what do you think is driving some of that better toll momentum overall?\\

I want to say that Japan, I think Japan is somewhere straightly in-line with the secular type of decline. So I think Japan is in the – in this 3% to 4% type of a decline altogether, I mean all the categories and I don’t think in the longer term this should change ups and obviously any other changes to the market. But as we’re today I mean, this is one should expect as a baseline for Japan total category should be some more I think in the range of 3% to 4%. Now there is some, I think JT was taking some price increases on a C category, okay. They were relatively lower total share, but I think there might be some elasticity kicking in and always on a quarterly basis Japan numbers, you have to properly, one have to properly adjust for all the pipelining of the new product launches on a – it’s always on a conventional business, but I think it still continues. There might be some comps as well when JT was taking – last year [indiscernible] as I said nothing today would indicate that the total category trend in Japan would be outside 3% to 4%--

Okay, thank you. And just one last follow up on capacity, I know you’ve outlined a lot of things about that, if you clarify this one, forgive me if I missed it. But, I know you had been saying you expected to be off of capacity constraints at the end of Q1 that’s now obviously been a few weeks. Are you still rationing devices in Japan or do you have the flood gates open or what is the right way to think about, where you sit today?

We start shipping, we start slowly lifting the quotas for Japan as of Q2, but we will not be in a position to significantly lift it before Q3 – the devices because we’re still catching up with the capacity of HeatStick. But capacity of HeatStick every month from the January, February, March, we’re already increasing it, you can see this in our shipments and we’re going to continue doing this for the whole year.

Okay, great, thank you very much.

Ladies and gentlemen, now we’ll conclude today’s question and answer portion on today’s call. I’d hand the program back over to management for any additional remarks.

Thank you very much. That concludes our call for today. If you have any follow-up questions, you can contact the Investor Relations team. We're back here in Switzerland. Thank you very much. Have a great day.

Ladies and gentlemen this will conclude the Philip Morris International first quarter 2017 earnings conference call. You may now disconnect your lines and have a wonderful day.