Jacek Olczak – Chief Financial Officer Nicholas Rolli – Vice President, Investor Relations.

Bonnie Herzog – Wells Fargo Judy Hong – Goldman Sachs Matthew Grainger – Morgan Stanley Chris Growe – Stifel Nicolaus James Bushnell – Exane BNP Erik Bloomquist – Berenberg Vivien Azer – Cowen & Company Michael Lavery – CLSA Owen Bennett – Nomura Adam Spielman – Citi.

Good day and welcome to the Philip Morris International Third Quarter 2014 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.

In order to ask a question, please press the star key followed by the number one on your touchtone phone at any time. Media representatives on the call will also be invited to ask questions at the conclusion of the 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 2014 third quarter results. You may access the release on our website at www.pmi.com.

During our call today, we’ll be talking about results for the third quarter of 2014 and comparing them to the same period in 2013 unless otherwise stated.

A glossary of terms, dated tables showing adjustments to net revenues and OCI for currency and 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 are at the end of today’s webcast slides, which are posted on our website.

Please note that reduced risk products, or RRPs is the term we use to refer to products with the potential to reduce individual risk and population harm in comparison to smoking combustible cigarettes. Today’s remarks contain forward-looking statements and projections of future results.

I direct your attention to the forward-looking and cautionary statements disclosure in today’s presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. It’s now my pleasure to introduce Jacek Olczak, our Chief Financial Officer.

Jacek?.

Thank you, Nick, and welcome ladies and gentlemen. Our volume and financial results in the current quarter came in slightly above our expectations.

Our organic cigarette volume decreased by just 0.4% due to an improvement in industry volume trends and higher PMI market shares in the EU and EEMA regions which nearly offset relatively modest volume declines in the Asia and Latin America and Canada regions.

Net revenues, excluding currency and acquisitions, increased by 4% while adjusted OCI was up by 4.3% on the same basis. This growth was driven by the EEMA and Latin America and Canada regions, thanks in large part to higher pricing, most notably in Russia. It was partly offset by previously announced investments behind our brand and iQOS.

Adjusted diluted EPS, excluding currency, grew by 10.4% to $1.59, driven primarily by continued strong profit growth across the EEMA and Latin America and Canada regions. For the first nine months of the year, we achieved growth in currency-neutral adjusted diluted EPS of 11.9%.

Let me remind you, however, that we will face a much more challenging comparison in the fourth quarter. Ex-currency adjusted diluted EPS grew by 19.4% in the fourth quarter of 2013 and the pattern of our expenses this year is weighted much more heavily to the remainder of the year.

In addition, we will be making significant investments in the fourth quarter behind the pilot launches of our iQOS platform and Marlboro HeatSticks in Nagoya, Japan and Milan in Italy.

We will also make additional investment in the continuation of the rollout of Marlboro Red 2.0 as well as the absorption of underlying costs attributable to the optimization of our manufacturing footprint.

As announced in our earnings release this morning, we are revising our 2014 reported diluted EPS guidance to a range of $4.76 to $4.81 compared with $5.26 in 2013, due predominantly to the impact of unfavorable exchange rate movement. Since July, we have witnessed a sharp decline in the value of certain key currencies versus the U.S.

dollar, in particular the Indonesian rupiah and the Russian ruble. Accordingly, at prevailing exchange rates our guidance now includes a full year unfavorable currency impact of approximately $0.72 per share versus $0.61 in our previous guidance.

In addition, there was one additional cent in the third quarter in after-tax asset impairment and exit cost related to the termination of cigarette manufacturing in the Netherlands, and it is anticipated that there will be a further one cent in the fourth quarter related to the closure of our factory in Australia.

Our underlying business performance is slightly better that our previous expectations. While consumer downtrading and heavy discounting in Australia have persisted, there has been an improvement in the EU region and Indonesia and continued strong profit momentum in the EEMA and Latin American and Canada regions.

Excluding the impact of currency and after-tax impairment and exit costs totaling $0.27 related to previously disclosed footprint optimization initiatives, our adjusted diluted EPS are projected to increase by approximately 6.5 to 7.5% compared to the $5.40 achieved in 2013.

Our revised guidance results in a narrowing of the growth range around its midpoint. I will now discuss the recent developments in key regions and markets, starting with the EU region. The third quarter confirmed the improving cigarette industry volume trend with a decline of 3.4%, thereby bringing the year-to-date September decline rate also to 3.4%.

This represents a significant moderation compared to the 7.9% decline in the same period last year. (Indiscernible) improvement to a slight decline in illicit rate, a slowdown in the growth of e-vapor products in several markets, and (indiscernible) switching to fine-cut product.

The improved trend in cigarette industry volume is visible across all six of the largest EU region markets by volume, with a particularly strong improvement in the worst affected market in southern Europe.

While we do expect to see some acceleration in the decline in the fourth quarter due to recent price increases, notably in Germany, and the impact of the more challenging industry volume comparison versus the fourth quarter of 2013, we are now forecasting a full-year decline of approximately 4%.

Our market share performance in the EU region continues to be very strong with growth of 1.2 points in the third quarter to 39.7% and 1 point year-to-date September to 39.8%. The growth has been broadly based with share gains this year in all six of the largest EU region markets by volume.

Our share growth reflects the strength of our key international brands, Marlboro, L&M, and Chesterfield. These brands now represent the top 3 industry brands in the region. In the third quarter, Marlboro gained 0.2 share points to reach 19.1%, the growth momentum being reinforced by the successful rollout of Marlboro Red 2.0.

L&M’s share was stable at 7% with a notable performance in Germany. Chesterfield continued its particularly strong performance, gaining 1.4 share points to reach a regional share of 5.8%. The share growth was driven by Italy, where it was price repositioned in February of this year, as well as by successful line extensions in Poland.

The combination of more modest cigarette industry volume declines and share gains has resulted in an improved PMI volume performance. Were it not for the issues related to the excise tax structure in Italy, this would have translated into ex-currency adjusted OCI growth in the EU region year-to-date September.

In addition, our profits are being impacted by costs related to the ending of cigarette manufacturing in the Netherlands and to the build-up of our commercial infrastructure in the U.K.

We are cautiously optimistic that as of 2015, the EU region should contribute to PMI’s profit growth, provided that improved cigarette industry volume trends continue. I will now discuss some of our key markets in the Asia region, beginning with Japan.

Year-to-date September, industry volume in Japan declined by 3.2%, which is in line with our forecast decline range of 3 to 3.5% for the full year. The third quarter provided further evidence of our success in stabilizing our market share.

Excluding the impact of trade inventory movements, our market share has remained around 25.9% since the fourth quarter of 2013. The share stabilization has been driven primarily by Lark, which is performing well following the successful morphing of the Philip Morris brand in April, as well as the recent revamp of the Lark brand family.

Our share has also benefited from the rollout of the Be Marlboro marketing campaign and the August launch of Marlboro Clear Hybrid, a smooth-tasting, regular to menthol capsule product which achieved 0.6% market share in September.

Going forward, we believe that our pipeline of new innovative products should further reinforce our competitive position in Japan.

In the Philippines, third quarter tax paid cigarette industry volume was down by 3.2%; however, as Mighty Corporation continues to significantly under-declare its sales volume for excise tax purposes, the trends in the tax paid market remain distorted. We estimate that Mighty is paying excise taxes on less than half of its total sales.

Market research (indiscernible) smoking incidents and at daily consumption showed continued resilience. The Bureau of Internal Revenue issued its expected regulation on tax stamps.

This requires manufacturers to affix tax stamps on all locally manufactured packs of cigarettes; however, there are still significant technical issues with the production of the stamps, resulting in a delay in implementation. In Indonesia, cigarette industry volume trends are subject to quarterly fluctuations.

This was evident in the third quarter when industry volume increased by an unexpectedly vigorous 4.9%, driven by growth in the machine-made kretek segment. On a 12-month moving basis, industry volume is up by 2.8%, and for the full year we expect industry volume to grow by around 2%.

While our market share remained below the previous year’s level, we continued to achieve positive sequential share momentum with 35.5% in the third quarter following shares of 34.6 and 34.9% in the first and second quarters respectively.

This growth has been driven by our strong performance in the growing lighter tasting, machine-made kretek segment behind Sampoerna A, U Mild, and Dji Sam Soe Magnum Blue. We have also seen a recent stabilization in the share of our key hand-rolled kretek brand, Dji Sam Soe, as competitive brands have crossed critical price points.

Let me now turn to Russia where our business performance continues to be strong. In (indiscernible), we reached a market share of 27.4% and on a year-to-date August basis our share increased by 0.9 points to 27%. The strong performance was driven by (indiscernible) and Parliament, mid price L&M, and low price Bond Street and Next.

2014 has been characterized by significant retail price increases driven in large part by the sizeable excise tax increase that took place at the beginning of the year. Retail prices have increased by some 17% in the premium segment and 30% at the low end of the market.

This has resulted in an estimated September year-to-date cigarette industry volume decline of 9.4%, and we expect a decline of 9 to 10% for the full year; however, we have been able to boost margins through higher prices.

On September 20, the cabinet submitted draft amendments to the tax code, including proposed excise tax rates for the period of 2015 to 2017. This proposal was submitted to the Duma for further consideration and approval.

The amendments are essentially in line with previous legislation and do not include features that we consider to be particularly disruptive. Should the amendment be signed into law by the president, as foreseen this November, the new excise tax rates would take effect on January 1, 2015.

While cigarette industry volume has declined significantly this year in Russia, it has remained essentially stable in the rest of the EEMA region. This stability is attributable to Turkey, the Middle East and North Africa. Our business is performing well. We grew our year-to-date September regional market share by 0.1 points to 25.1%.

Combined with strong pricing, this led to an increase in original adjusted OCI, excluding currency and acquisitions, of 20.8% year-to-date September. The business outlook remains very positive thanks to the strength of Marlboro and Parliament in many key markets. Marlboro has been one of the key drivers of our favorable global market share momentum.

In the third quarter, the brand gained 0.3 share points in the Latin America and Canada region, and 0.2 share points in the EU and EEMA regions. Its share was stable overall in the Asia region.

Parliament, our (indiscernible) premium proposition, has been a contributor not only to share growth but also to improved profits as its volume increased by 9.3% in the third quarter to 12.9 billion units. The brand gained share across a broad range of markets, including Japan, Kazakhstan, Russia, Saudi Arabia and Turkey.

Pricing remained a key driver of our adjusted OCI growth during the third quarter. Our pricing variance reached $491 million for the quarter and $1.4 billion for the first nine months of the year. This has been boosted by our new business structure in Egypt, partially offset by Italy.

During the third quarter, we increased prices in a number of markets across the region, most notably in Argentina, Germany, Indonesia and Spain. We are on track to achieve again this year our historical average of approximately 1.8 billion in annual pricing variance. Let me now take a moment to provide a brief update on our Reduced Risk product.

As I speak, we are in the final stage of preparing for the pilot launches in Japan and Italy of our heat-not-burn iQOS product platform and Marlboro HeatSticks. These launches will be made without any reduced exposure or reduced risk claims.

As already announced, the official launch of iQOS in Nagoya, Japan’s fourth largest city, will take place on November 4. iQOS kits and Marlboro HeatSticks will be available at over 1,000 retail outlets in Nagoya, including the world’s first iQOS flagship store located in a city center.

The iQOS kit will have a recommended retail price of ¥6,980 or approximately $65, while Marlboro HeatSticks in regular and menthol variants will retail at ¥460 per pack or 20, or approximately $4.29, at price parity with Marlboro cigarettes.

Our HeatSticks have been classified by the Ministry of Finance in Japan in a category that results in an effective excise tax rate that is lower than cigarettes. Our second pilot launch will take place in Milan in Italy later this year. For competitive reasons, we will not disclose any details at this time.

In September, our board approved a 6.4% increase in our quarterly dividend to an annualized rate of $4 per share. As a result, this year we will exceed our target dividend payout ratio of 65%, reflecting our strong confidence in our business fundamentals and future prospects. Our dividend yield last Friday was 4.7%.

During the third quarter, we spent $750 million to repurchase a further 8.9 million shares at an average price of $84.54 per share. We continue to target total spending of $4 billion on share repurchases during 2014.

Since the spring through the end of September this year, we have returned over $70 billion to our shareholders through dividends and share repurchases. In conclusion, third quarter and year-to-date results were slightly above our expectations. As mentioned, we will face a much more challenging comparison in the fourth quarter.

We have revised our 2014 reported diluted EPS guidance due predominantly to the impact of unfavorable exchange rate movement. On a currency neutral adjusted diluted basis, we have narrowed the growth range around the midpoint to approximately 6.5 to 7.5%.

While consumer downtrading and heavy discounting have unfortunately persisted in Australia, we have been able to offset this through a better performance in the EU region and Indonesia, while the EEMA and Latin America regions have continued to perform very strongly.

The iQOS pilot launches in Japan and Italy this quarter mark an important milestone for our Reduced Risk products portfolio. We are excited to bring this product to market and strongly believe that this could represent the first step in a positive paradigm shift for both PMI and the tobacco industry.

Looking ahead to 2015 and 2016, we remain confident that our business fundamentals are improving and confirm our goal of returning to currency neutral net revenue and adjusted OCI annual growth within our mid to long-term annual target rate of 4 to 6% and 6 to 8% respectively, after taking into account the anticipated investment behind the commercial expansion of our Reduced Risk product.

On this basis, we target a currency neutral adjusted diluted EPS annual growth rate of 8 to 10% for this period. Thank you. I will be now happy to answer your questions..

[Operator instructions] Our first question comes from the line of Bonnie Herzog from Wells Fargo..

Good morning, Bonnie..

Hi Jacek. I guess I’m trying to understand a few moving parts.

On one hand, your total shipment volume was better than expected and you took share, but on the other hand your operating margins were down 230 basis points, so I’d be curious to hear how much of the margin pressure you experienced in the quarter was from a negative mix shift in the portfolio versus the higher costs you’ve been experiencing.

And then could you give us a sense of how downtrading pressures have been trending so far in Q4?.

There is some mix pressure, obviously, coming mainly from Asia, from Australia, but I think it’s more due to the increased investment, as previously anticipated or announced, in the second half of the year.

We have increased the investment in Q3 and we will have more of the investment going into Q4 for the reasons which I mentioned in my remarks, so this is what stands behind the movement in operating margin..

Okay, and then I have a few questions on Asia, specifically Japan.

Are you seeing any shift in your portfolio mix due to the tax increase, and then could you quantify for us the negative impact of inventory movements or maybe give us a sense of how much this impacted your volume and profits in the country in the quarter?.

Well, we could see a better performance of Lark partially following the successful morphing from Philip Morris into Lark, and also some marketing initiatives which we put behind the brand. Lark obviously is also slightly more—you know, lower price than the premium brands in the market.

I think it’s a little bit too early to say what this pricing move—you know, unequal pricing moves over 20 and ¥10 have created in terms of a dynamic behind the brand, but yes, I think Lark is doing slightly better than Marlboro in this comparison.

When it comes to that adjustment which we’re making in Japan, it’s essentially we’re trying to adjust the inventories to reflect the total market outlook and still year-on-year.

I mean, our lower share, as you might notice, we stabilized our share on a sequential basis but versus last year we’re still down, and these adjustments are essentially to represent (indiscernible). So I think you have—just to give you a number, I think on the inventory you have about half a billion units on inventory adjustment in Q3..

Okay, that’s helpful. Then my last question is on the e-vapor slowdown in the EU that you mentioned.

What are you seeing in terms of the key trends and pressures on this category, and then does this give you even more confidence in your iQOS platform?.

Well, the trends essentially are the same trends which I talked about, that we talked about at the investors’ day on the second quarter. The consumers aren’t moving into (indiscernible) system.

I think we all know the reasons behind it – I mean, the first product launches in the e-cigarette category are not really satisfying the consumer, so the acceptance rates are falling down. That’s about the trend. Most of the markets, in essentially all of the markets, we see the same, so it’s just the continuation of the trend.

Now does this give us more optimism behind iQOS? I think it was more than a year or two years ago when we said that the current technology behind the e-cigarette doesn’t (indiscernible) that well. We think that iQOS is by far a much better satisfying product. We have confirmed it in our tests before going to the test market.

As you remember, the acceptance rate—I mean, consumers who fully switched from a conventional cigarette, combustible cigarettes to iQOS proposition were really very high – they were reaching 30%. I think we were encouraged by this result and hence we’re going to the test market.

So I don’t think this change in the trends or continuation of this negative trend in e-cigarettes gives us more confidence behind the iQOS. Frankly speaking, we have that confidence, so we are a very high level of confidence when it comes to iQOS..

And then maybe lessons learned on pricing, too, just in terms of the affordability of the e-vapor category relative to where you’re pricing iQOS and the HeatSticks. You’re pricing them, you mentioned, at parity I think with Marlboro, I believe you mentioned..

Yes, this is how we positioned the product in Japan, although we are not disclosing the details for Milan, but you understand our philosophy – I mean, that has a benefit, therefore, I think that product deserves to be sold at a premium price, so this is—I think we’d state what we have said before, that that’s the positioning based on how much effort we have put into developing this product, despite the fact that we’re not claiming other benefits in Japan.

But we are aware about also the science which we have put in validating the benefits of this product. I think it all comes together and makes this product deserving of being put in the premium segment, at the premium price..

All right, thank you, Jacek..

Thank you very much. .

Our next question comes from the line of Judy Hong from Goldman Sachs..

Hi Jacek. So first, just maybe on FX, and obviously the currency market continues to be very volatile, and if we just assume maybe prevailing rates, just trying to gauge the impact on 2015, really, and I get to number of something like a negative $0.35 or so.

So can you just confirm that that’s kind of in the ballpark of where you see the impact in 2015 at current rates, especially when you take into consideration the effective hedge rates on the yen..

I wouldn’t go into 2015 at this stage. You know that our practice was we always gave this—we talk about the impact of the currency at the time when we give the guidance for the year.

One thing, which I’m not presumably disclosing anything new, if you look what is happening in the currency market over the last 24 hours, 48 hours away, it’s an extremely volatile market, so I think it’s another presumably reason when it’s better not to give any number or confirm any sort of range at this stage..

Just on the yen though, Jacek, I think the last time you talked about the effective hedge at 98 for this year, has there been any change to that number as we think about the year-over-year impact?.

Yes, there is a bit of the impact of the yen. The effective rate will be higher than 98. In the revised guidance for the currency at the spot rate which we gave today when we revised the impact by an additional negative $0.11, yen actually just (indiscernible) contribute $0.01.

I mean, most of the impact which we get, which we have in this $0.11 additional is coming from Russian ruble and the rupiah, the Indonesian rupiah. So yen just adds an additional $0.01, and very much because last portion of our cash flow to revenues from Japan is already—was already hedged..

Okay. Then just in terms of what you’re seeing and the Russian market, just wondering if any of the recent volatility in the currency fluctuation is having any impact in terms of demand or the pricing, the competitive dynamics in that market.

Your volume in the third quarter in Russia was up 0.8%, market share obviously was up, but was there any benefit in terms of any year-over-year inventory movement that boosted your shipment number as well?.

No, actually the volume, the shipment volume I think was down by 0.4. The shipment volume was not up. Market share was up, and this partially is why our shipment volume is better than overall market performance. It’s partially coming from the strong performance of our brands.

The share advancements which we are realizing in Russia at the tune of the (indiscernible), so that’s significant.

There is obviously some timing of the shipment to our distributors, but I think overall it’s the performance of both Parliament, which you know that’s very positive if you take into consideration the magnitude of the pricing which we have realized in the market, but also Bond Street, so it nicely—you know, I think the portfolio there is nicely complementary, and that stands behind the better share and hence the better shipment versus the total market..

And any color on the recent trends given the recent volatility in that market?.

Yes, sorry – I missed this one. Not really. I mean, you see our outlook for the full year even, taking into consideration the implemented and announced price increases in Russia, it’s still that the market is going to decline in the range of 9 to 10%.

If you would just calculate what is the resulting price elasticity, everyone would realize that Russia is a very normal for our category for a tobacco category elasticity range, so that (indiscernible) at this stage any headwinds coming from the currency, from inflation or other macros. Now, this is the situation as of today.

We will have to obviously watch, and we do watch carefully how the situation may unfold into the next period, but as I said, I think our comfort on Russia is also coming through the well-laddered portfolio of brands, and I’ll repeat myself, starting with the premium Parliament in the premium, going through the value, mid-price brands, low price brands.

So I think on that one, I think we should be able to hedge any potential headwinds if they were to materialize..

Got it. Okay, thank you..

Thank you very much, Judy..

Our next question comes from the line of Matthew Grainger from Morgan Stanley..

Hi, good morning. Thanks Jacek..

Good morning, and congratulations I guess, right?.

Yes – thank you, it’s exciting. So two questions from me. First, I wanted to follow up on the price mix question, specifically for Europe. I’d expected to see some sequential improvement in pricing realization within the region, given Germany, Portugal, Spain, but that didn’t seem to materialize during the quarter but is more at the regional level.

Market share trends were very strong – maybe that’s positive, but just wondering if you’re seeing incremental downtrading overall within your portfolio or shifts within Marlboro to some of the lower priced variants that are weighing on overall pricing realization..

I mean, the pricing – yes, it was very low pricing. The variants coming from the EU this quarter, it’s partially the timing when we took the price increase in Germany, and obviously there was a negative – which is in this number – coming from Italy.

Just to remind, we are in the VAT absorption for the three quarters of this year, obviously, including the third quarter is going to be about behind us around the mid of the fourth quarter, and obviously there was a Chesterfield repositioning.

If I would look in detail market by market in the EU region, I would see—I can see the positive pricing variance coming essentially from most of the countries, with the exception, as I mentioned, of Italy, so Italy is an overall drag, if you like, on the pricing variance in the region.

Obviously downtrading – I think again I would have to go to Italy. I mean, Chesterfield, which is now—you know, recorded market share well above 10%, there is a bit of a decline of Marlboro to the tune of about a point.

So yes, there is some downtrading, but this is also the reason why we have lowered the beginning of the price of Chesterfield in order to stop total market share erosion on our side..

Okay..

And the brand responded very well, so I think that part of the exercise went very well..

Okay. So really, the only thing that would change much sequentially in the fourth quarter would be the headwind from Italy becoming less severe..

On the pricing variance, yes..

Okay..

On the pricing variance, because on the OCI, as I mentioned in my remarks, one of the tests markets which we’ll be conducting is in Italy, is in the European Union, and the second EU was on the forefront and is on the forefront of the rollout of Marlboro 2.0 architecture; hence, in our remarks I think I made this comment that despite the fact that the volumes and our shipment volume is performing very strongly and is great for this year and even greater for 2015, however this year our profitability will be impacted as we cannot convert it into the profitability growth due to Marlboro 2.0, iQOS and some underlying costs due to shutting down the cigarette manufacturing at our factory in Holland..

Okay, that’s helpful. Thanks.

Secondly just on currency, specifically on hedging, given the persistence and the magnitude of the currency headwind, have you considered at all changing the internal philosophy toward how you manage FX risk, perhaps including more active hedging or, if not that, maybe encouraging local country managers to more actively offset transactional FX through pricing or discretionary reductions in operating costs?.

This would require a significant change to the risk profile, if you like, which we’d like to have. I mean, as is presumably known to the community, most of the impact of the currency on our results comes from the translation, and the range of 70 to 80% of the impact which we have on our translation is not on the transactions.

So our philosophy obviously has an impact on our reported results, but I don’t think we should be moving closer to something which would add an element of speculation into—volatility into our performance..

Okay. Then just to confirm, historically we’ve thought of your hedging practices as isolated within sort of euro-yen and perhaps dollar-yen. Are there any others that you are actively hedging, just when we’re thinking about the disconnects between our currency model and—.

There are some hedges which we’re doing on the—associated with the leaf purchases in Turkey, but most of the hedges are around the yen and the balance sheet hedges on our positions on the euro..

Okay. All right, thank you again, Jacek..

Thank you very much..

Our next question comes from the line of Chris Growe with Stifel..

Hi, good morning..

Hi Chris..

I just had a question for you to start off on—just to understand the third quarter and maybe the fourth quarter, the phasing of costs that may be coming through.

If I could just list what I was—when I’ve been watching this, obviously the Marlboro 2.0, obviously there are some costs related to that – I think that cuts across all regions – obviously the closure of Bergen op Zoom, maybe a little bit of Australia.

And then I guess also related to that, the Reduced Risk products, is that heavier fourth quarter spending versus the third quarter, and do you have any color you can add around the phasing and maybe in general how much those costs are a burden in profit right now?.

Certainly, Chris, I will give you color; but I would start with the 2013 fourth quarter, because if you would look at our performance in 2013, you’ll realize that our phasing of the costs in the last year was much more skewed towards the first half of the year, or the first three quarters of the year.

So adjusting apples to apples, I had $200 million positive cost variance in Q4 of 2013, so that’s my starting position going into Q4 of this year.

It is now combined that the pattern of our spending on initiatives is much more skewed towards the second half, and in particular to the Q4 of this year, and that actually creates the swing on the cost Q4 on Q4 going in the range of 400, maybe 400-plus even in this comparison. (Indiscernible).

Now, drivers of this additional—of this investment in the second half or in the Q4 of this year is, as I mentioned in the case of the EU before, is iQOS launch in Milan. There was some preparation cost already falling into Q3, but most of that will hit my Q4 results.

Marlboro 2.0 would be the remainder part of the markets in the EU which would roll out the Marlboro new architecture in the Q4, and there was this underlying cost associated or related to the closure of the factory.

To give you magnitude, the underlying costs which we carried this year due to the restructuring both in Holland and in Australia is in the range of about—will hit my Q4 results in a range of about $40 million.

So you start adding these numbers, you will see why we’re saying that the Q4 results—I mean, it will not be as great as Q3 or Q2 this year, and this is reflected in our guidance..

Sure. That was actually very good color. Thank you for all that detail.

If I could ask a second question – in relation to your guidance for the year, which you’ve now kind of narrowed the guidance range for EPS, do you have the same assumption for Australia built into that guidance? Has that gotten any better or any worse than what you thought, even back from sort of the investor day back in June?.

No, it didn’t get any worse or didn’t get any better.

As I said, unfortunately the heavy discounting and the competition in the low part of the market, as it intensified at the beginning of the year, it continues to be pertinent, and I think it’s maybe also to be more on a positive side, one of the competitors made an assumption that you can have volume growth in that market by being very aggressive on the price.

You will not break the strategy until you switch off the volume growth of a given brand, so I think what we’re doing, part of our strategy despite the fact that it is obviously costly financially, I think it actually may lead to bringing some logic to the behavior in the market. So this is all in our guidance.

I think versus the Q2, especially at the investors’ day, which I think prudence at that time had dictated that we had to recognize that there was this potential headwind coming from Australia, I think at that time we were waiting for more confirmation of positive trends coming from other geographies, which were nicely materializing in Q3.

But as I said, I think it would be imprudent to bet on this development in Q2, and now we’re in a very comfortable position to say that this lower end of the range, of the guidance which we gave at that time, is no longer something which we should be worried about, and we can comfortably deliver in the midpoint of that range.

The drivers, I think, are well known – EU had a spectacularly good improvement on the total market, and our market share continues to do very well. Indonesia is a very positive surprise – it’s coming. We knew that the market might be stronger, but I think last quarter Q3 has confirmed that the market is going in the right direction.

Also, the growth momentum—you saw our OCI, adjusted OCI growth in EEMA and Latin America – I mean, they’re really coming very strongly.

So this is very important for us, not only from a Q3 perspective but I would say even more important for us from a 2015 and beyond perspective, that the roadmap which we have laid down for this year, we step-by-step made progress and therefore we should return to the higher level of growth in 2015 and ’16..

Okay, that was very good – thank you. I agree, so thanks so much. Speak to you soon..

Thank you..

Your next question comes from the line of James Bushnell from Exane BNP..

Hi, good morning. Thanks for taking my questions. I have two, please. The first is on the tax situation in Italy. I just wondered if you could give us your latest thoughts as to what might be happening and when. I think January ’15, we were hopeful that something might change. Then my second question is on plain packaging in Europe.

When the first country passes legislation, whoever that might be, do you think you could give us a roadmap about what would happen, and would you be hopeful that a legal challenge to that could either delay or stop the implementation of plain packaging, or is it just a case of having to take a country to court and then having to do that while their going ahead with the measure? Thank you..

Okay, I’ll start with Italy. The tax restructuring in Italy is following its normal legislative process. We expect the objective is that this should happen still this year, so it would be implemented as of January 1 next year.

I mean, that’s the objective and we’ll see how it works, but as I said, the restructuring is being discussed and is following the normal Italian legislative process.

When it comes to plain packaging, the second question which you raised, there’s nothing really new which has happened recently, because we were aware about Ireland, we were aware about U.K.

Yes, there was a statement from the Ministry of Health in France that she would propose the legislation implementing, calling for implementation of plain packaging. To date to our knowledge, this is not a governmental position and no legislative initiatives have been made, at least to date, into this direction.

Now, litigation which you have mentioned quite rightly, it’s obviously in our tool box of actions which we can take in order to protect the extremely valuable trademarks which we have. But there are also other elements which we are exploring before we reach into litigation.

But yes, there is litigation which clearly is something which we will not be shy to use if this is what will be required by us. One thing which is important to note when we talk about the U.K.

and Ireland, if I am not mistaken, there are nine countries today or member states in the EU which have raised their concerns to Ireland in particular, and I think there are two countries already which have raised their concerns to the U.K. vis-à-vis they announced or the indication of introducing the plain packaging in this country.

It clearly demonstrates to you, or demonstrates to us that a number of member states in the EU itself are pretty much concerned whether this is the right policy to be implemented, both from the perspective of the principles of internal market – and let’s remember that the whole purpose of creating the EU and the legislative powers which were given in the form of directives, were to support the development of internal markets.

Frankly speaking, plain packaging is not necessarily something which goes in this direction. So yes, to summarize this, plain packaging is an element in our tool box and we will not be shy to use that if this is what will be required..

Okay, thank you very much. If I could just follow up – and sorry to bring up currency again, but I noticed that the gap between your FX effect on your sales line versus your OCI line is widening, which presumably reflects a bit more transactional hit.

I just wondered if you comment, is that still mostly the yen or does the Russian ruble come in there as well?.

No, mostly in our revised guidance, the largest impact was coming from the ruble, the rupiah. The yen, as I said earlier, was $0.01. We obviously had a positive Swiss franc on the cost side, which more than offset the negative coming from the euro..

Sorry – I meant in terms of the transactional FX exposure that you’ve seen in Q3.

Is it mostly from the yen, or is there also an impact from the ruble where I believe your costs are predominantly not in rubles, whereas your revenues are?.

No, I think it was more from the ruble. I think it was more from the ruble on the transactional side..

Okay, great. Thank you very much for your help..

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

Hi Jacek..

Hi, good morning..

I was hoping you could discuss in a little more detail about the tax treatment of the HeatSticks in Japan, and then perhaps in Italy as well.

I was wondering if you could give us some more perspective on the tax differential, what is it driven by – it is lower rate, is it taxed by—you know, what the basis for that is, and then the ability of that tax treatment to be extended into other countries in the various regions. Thanks..

Tax treatment in Japan results that the iQOS HeatSticks will pay a tax about 20% lower than the tax on cigarettes. It’s classified in a different tax category for the reasons that it is not a cigarette and this is not combustible, so there is another level to the tax category and the Ministry of Finance has decided to classify this product there.

It’s also very much similar to what has happened with the competitive product in that market – I mean Ploom from JT, which also is classified in this tax category.

I can’t tell you more about Italy, about the tax classification, but as we have said also during investors’ day, I think we have a pretty strong case that this product, for various reasons, should enjoy better taxation than the combustible, conventional cigarettes.

Now, how this will materialize, we’ll have to see, but this is what we, in our engagement in the various markets, took the direction which we take..

Okay. With respect to—again, another foreign exchange-related question.

Given that that has such a material impact on the balance sheet and the ability to buy back stock, is this really implying that in 2015, the amount of buyback available to Philip Morris will be much more at the low end of what you suggested, and does that therefore imply, given your confidence in hitting kind of an 8 to 10% constant currency EPS target, that the operational component of next year perhaps looks a bit stronger?.

We had said, I think, at the investors’ day that we’re looking at the range of 2 to $3 billion for next year, but obviously the final target, final amount will depend on two factors.

One is obviously the acquisitions, and second is also importantly the development on the exchange rate, which obviously with our limited headroom to further leverage the balance sheet in order to support the single-A rating, that’s something which we have to and we are watching very carefully.

When we give the target in February, the target will reflect the development or potential developments on both sides, so I don’t want to go into—you know, commit to any number for next year. As I said, we will announce it in February..

Okay, thank you..

Your next question comes from the line of Vivien Azer with Cowen & Company..

In terms of South Korea and the potential for a proposed tax increase, can you speak to the likelihood of that actually passing?.

Hi Vivien. Well, I think there is a high likelihood that the tax increase will happen. What we don’t know at this stage is the magnitude of that increase, if it’s going to be in the range of apparently 1000, 1.5 or 2001, we’ll have to see.

So this is what I can tell you at this stage, and clearly it is significant, a very significant tax increase, but we also have to remember, if my memory is not wrong, that we’re approaching the tenth anniversary of no tax increase in Korea.

So I think we’ll have to take this magnitude also from the perspective of when was the last time Korea had adjusted the tax rates..

That’s fair. Thank you. Your key competitor in that market has not always priced, I think, the way that everyone would have hoped.

Is there any reason to think that they would be more constructive on pricing around the tax increase?.

Well, I wouldn’t like to go into speculation..

Fair enough..

I mean, the investment community knows that the past performance is not necessarily the best driver of the guidance for future performance, so let’s stay with this. I don’t know. I can’t tell you..

Okay, fair.

In terms of platform 2, can you just confirm that it remains on track and roughly one year behind platform 1?.

Yes, yes. Nothing’s changed there..

So would we expect a test in the coming six months?.

No, we should expect the test in 2015 to end of 2015..

Okay..

But we say that the platform too is about one year—is a year behind. As per plan, it’s behind the platform 1..

So not even a consumer test? Because in Japan and Italy, even though you’re going to city test in the fourth quarter, didn’t you go into do some consumer testing that you spoke about at CAGNY in February?.

Vivien, we’re talking about the two levels of consumer testing. One is the consumer testing in terms of the all over test, which obviously will be done—we will be doing first; and then there’s the consumer testing in terms of launching into the selected city or close to geography.

So always, we’re going in the same—we will repeat the same sequence as we have done or as we are doing so far with iQOS platform 1..

Terrific..

So the second part of 2015..

Understood. My last question is on the FDA submission that you’re working on jointly with Altria.

Any progress or updates on that? Do you have a sense of when you might actually make a formal submission to the FDA on MRTP?.

Well, I think it was subject to us concluding the clinical studies and closing the entire scientific package which is to support that submission, so the clinical studies as per plan, we will be completing them in the mid of next year, second quarter next year, and then the preparation for the pack of submissions can only really start afterwards..

Very clear. Thank you very much..

Thank you very much..

Our next question comes from the line of Michael Lavery with CLSA. .

Just turning to Indonesia, you indicated that the guidance for the category for the year would be around a 2% growth rate, which implies around a 1% decline in the quarter for 4Q. I know that the comp gets about 2 points tougher, but that’s around a 6 point deceleration.

Is there anything you think that’s looming that would drive that, or is that just a conservative number? How are you thinking about the category dynamics there?.

I think we are looking at little bit on a longer time span, not just the quarters. As I indicated in my remarks on the 12-month moving basis, the market is in a 2.4% decline. I think the 2% sounds to us—seems more realistic for the full year. Maybe it’s going to come a little bit better.

I have to admit that Q3 came better than we expected, so that we recognize by changing a little bit—changing the outlook for the full year.

The market may come better because there’s not much in headwinds which I can see in the market – actually, quite opposite because as long as nothing is dramatically changing in terms of drivers of the bit lower performance last year, i.e. fuel subsidies or removal of partial fuel subsidies. I think there was spikes in food inflation.

I think that these things are slowing coming behind us, so maybe the market can even do better. But let’s see. I think 2% is about to be realistic, the realistic number as we see it at this stage..

Okay, that’s helpful. You had said that your July share was just over 35%, and you came in the full quarter at 35.5.

Was that a sequential progression, so you would have finished the quarter maybe around 36%, and could you give any sense of how that’s continued into 4Q or for September?.

There was sequential growth of share in Indonesia, quarter-on-quarter and also within the month.

This is very much driven by the fact that Dji Sam Soe competitors, main competitors of Dji Sam Soe have crossed the critical price point of Rp12,000 per pack, and as we expect at this moment that Dji Sam Soe will compete with the brands without this obstacle, if you like, of the psychological price point.

We should observe the better performance, and Dji Sam Soe is coming actually now flat on the third quarter and year-on-year, so we stabilized the brand. Obviously our entry with extending the brand into machine-made kretek, both on full flavor and lighter variants, helped a lot, so this is very good.

So yes, we’re growing sequentially there, and I think we should expect this going through the year, although I think for still on a full-year basis we will be below our market share of the last year. But I think it’s a very nice starting point which we’re building already now into 2015..

And what is the mix impact from that? Obviously you’ve lost the low-end brands and that would seem to be a benefit.

Certainly the hand-rolled Dji Sam Soe pressure would offset some of that, but if that’s stabilizing, is your mix a positive benefit now or is that still pressured?.

There is. I don’t think it’s that much of—I mean, there is some mix pressure, but you have to remember that there’s a different tax level also behind the different price points and the different category of the product, so the margin differential is not necessarily fully translated. It can’t be fully translated just from the retail price perspective..

Okay, great – yeah, thank you. Then just on iQOS, you have the unit price that you mentioned. Does that have any flexibility in terms of the launch period, just for discounting or anything that—you know, obviously you want to get people to try this or get it in people’s hands.

Certainly for a premium product, I’ve seen that pricing approach, but what’s the right way to think about adoption and how to make sure that’s not a prohibitive cost for people to think about up front?.

By the regulatory ramifications which we have in Japan, we cannot have a discount on the HeatSticks, on the Marlboro HeatSticks..

Oh no, sorry – I didn’t mean the HeatStick, I mean the iQOS unit itself..

It is an introductory price, and the whole offering, the introductory offering to the consumer, which will be going for the iQOS heating device, tobacco heating device..

So you do have room to put incentives on that?.

Sorry?.

You do have flexibility to how you price that in terms of just getting it adopted initially? I think you said it’s the ¥69.80, that’s the sort of list price, I guess, and you could work off of that to have an upfront discount or something?.

Absolutely correct. You’re reading this like you would be in Nagoya..

Okay, great. Thank you. Then just one last question on lower oil prices. I know certainly in Indonesia last year, we saw consumer sensitivity to inflation there.

Obviously every country is different, but very broadly speaking with the big move in oil, do you feel like that’s potentially a net consumer benefit enough to impact any volume outlook? Obviously it hasn’t—it’s a recent move and it hasn’t stuck for a long time necessarily, but is that potentially a positive in terms of how you just look ahead for the next three, six, nine, 12 months?.

I think it is positive. I think we all would like to have oil lower, right, at lower prices, especially Indonesia where the market, its consumers are more sensitive. Yes – I mean, that is the right direction, hence as I said earlier that it might be that the volumes in Indonesia will do a bit better than the 2% for the full year.

I mean, let’s see how this develops, but it’s positive, you’re absolutely right..

Okay, thank you very much..

Your next question comes from the line of Owen Bennett from Nomura..

Good morning, Jacek..

Good morning..

Just one from me. I was just wondering the pricing benefit from the change in business structure in Egypt.

I was wondering if you could quantify this, and can we expect this to drop off into next year when it laps?.

Well, the benefit is coming from in the past or in the year 2013, what we—the way we operated our structure in Egypt was that we’d been selling just the materials, the components, i.e. tobacco (indiscernible), et cetera. The manufacturing was taking place outside Philip Morris by the partners in Egypt.

As of this year, we’re fully owning the entire approach, fully owning the entire process, and we recognize the full cost of manufacturing, so this is all materials plus the conversion, et cetera, but also correspondingly we recognize the full revenue, i.e. the price which we’re charging to the first customer.

The impact of Egypt, of this accounting or reporting reflecting business structure, is in the range—at the top line at the revenue in a range of about $200 million. This is obviously the business organic growth which we are realizing this year, which is coming on top of this.

But this is how much Egypt is pushing or increasing our revenue, but you also remember you have an offset in the cost base. So when it comes to OCI, the net benefit which we’re realizing due to the structure is not really inflating the numbers between the two years. But there is organic growth in Egypt..

Okay, great. Thank you..

We have time for one final question today. Your last question comes from the line of Adam Spielman with Citi..

Hello, thank you for taking the question. I hope I can ask a question about 2015 and ’16, because you mentioned this in your press release. In it, you say and reiterate that you to hope to achieve 6 to 8% OCI growth constant currency, but you also mention the costs of the expansion of Reduced Risk products.

So the question is in the context of your entire OCI, is the commercial cost of the—the cost of commercializing Reduced Risk products material? I assume it is, and I assume that it’s going to be one or two percentage points, otherwise you wouldn’t have bothered mentioning it in your press release. That’s the question – thank you..

Yes, (indiscernible). Yes, there is an increased cost of iQOS which is already included in our overall target for the next year.

Obviously when we come in February, we will give the proper detailed guidance for the year, but from the very beginning we said that we’re targeting 6 to 8% adjusted OCI growth ex-currency in 2015 and ’16, and this number includes the cost, also obviously in the later part of this period, the revenue coming from iQOS.

So this is all included there, and there will be quite an increase or a substantial increase of our spending behind iQOS next year, but this number is included in our target..

Okay, but just to confirm, it is a material amount that is included?.

Yes, but I will not disclose—.

How material – I knew you wouldn’t do that, but that’s clear. Thank you very much. It’s helpful..

Thank you..

We’ll now turn the call back over to Nick Rolli for any closing remarks..

Thank you very much. That concludes our call for today. If you do have any follow-up questions, you can contact the Investor Relations team. We’re currently here in Switzerland. Thank you again, and have a wonderful day..

This concludes today’s conference call. You may now disconnect..