Good day and welcome to the Philip Morris International Fourth Quarter 2018 and Year End Earnings Conference Call. Today’s call is scheduled to last about 1 hour, including remarks by Philip Morris International management and the question-and-answer session. [Operator Instructions] I will now turn the call over to Mr.

Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, sir..

Welcome and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2018 fourth quarter and full year results. You may access the release on www.pmi.com or the PMI Investor Relations app.

A glossary of terms, including the definition for reduced risk products, or RRPs as well as adjustments, other calculations and reconciliations to the most directly comparable U.S. GAAP measures are at the end of today’s webcast slides which are posted on our website.

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 André Calantzopoulos, our Chief Executive Officer. Martin King, our Chief Financial Officer, will join André for the question-and-answer period.

André?.

Thank you, Nick and welcome ladies and gentlemen. I would like to begin with some general thoughts on our performance in 2018. We achieved robust results from our combustible tobacco portfolio and nearly doubled our heated tobacco unit in-market sales volume, driven by growth in all IQOS markets.

We fell short of our initial full year net revenue growth target provided in February last year, which was almost entirely attributable to lower than anticipated IQOS consumer acquisition in Japan and related distributor heated tobacco unit inventory adjustments.

In our view, this overshadowed an otherwise robust financial and strategic performance across the business. Clearly and understandably, this contributed to the overall decline in our share price, which was also pressured by broader market concerns surrounding the industry and the consumer staples sector generally.

While we recognize that the market is the ultimate judge, we find it difficult to understand the share price impact of certain developments in the industry last year, particularly those that were very U.S. centric and arguably less relevant to our international business.

Entering 2019, I believe that we have laid the foundation for a better business performance this year and beyond, thanks to significant investments in product portfolio development and organizational capabilities, including a state-of-the-art digital infrastructure to fuel our expansion.

As I will cover in my remarks in a moment, the underlying strength of our combustible product portfolio remains undoubtedly intact and our smoke-free products are the catalyst to accelerate our overall business growth. Let me now take you through the main elements of our full year results starting with volume.

Our total cigarette and heated tobacco unit shipment volume declined by 2.1%, notably reflecting the reduction in distributor heated tobacco unit inventory in Japan, which we explained during our third quarter 2018 results call.

Excluding estimated net distributor inventory movements, total shipment volume was flat, our best annual performance since 2012 with strong growth in heated tobacco units offsetting a decline in cigarette. This performance compares favorably to an estimated decline in total industry volume of 1.6% on the same basis.

Our cigarette shipment volume declined by 2.8%, the decrease was due mainly to lower industry volume, notably in Russia and Saudi Arabia, coupled with the impact of consumer switching from cigarettes to heated tobacco product, particularly in Japan, Korea and the EU region.

Increased shipment volume, notably in Pakistan and Turkey, driven by higher industry volume and in Thailand driven by higher market share served as a partial offset. Heated tobacco unit shipment volume increased by 14.2% to 41.4 billion units despite estimated net distributor inventory movements in Japan of approximately 17 billion units.

More importantly, our in-market sales volume for heated tobacco units nearly doubled, reaching 44.3 billion units, a significant achievement driven by all IQOS launch markets, including Japan and Korea.

Turning to our 2018 financial results, net revenues increased by 3.4%, excluding currency, driven by strong pricing of our combustible tobacco portfolio and heated tobacco unit shipment volume growth.

The users’ product net revenues reached $4.1 billion or 15.8% of total net revenues, with IQOS devices and accessories accounting for approximately $0.9 billion or 22%.

For reference, last year distributor inventory adjustment in Japan of an estimated 4.5 billion units adversely impacted our total net revenue growth, excluding currency, by approximately 1.2 points. The move to highly inflationary accounting in Argentina further impacted growth by approximately 0.6 points.

Our 2018 combustible tobacco pricing variance represented 7.6% of prior year combustible tobacco net revenues, with positive contributions from all 6 of our regions. Pricing was particularly strong in Canada, Germany, Indonesia, the Philippines and Russia.

The strong pricing performance in Russia benefited from a very favorable comparison following essentially no net pricing in the market in 2017. Also, in the Philippines, we benefited from improved industry pricing dynamics following the significant decrease in non-tax product availability.

On a currency neutral basis, adjusted operating income was essentially flat, while our adjusted operating income margin decreased by 1.3 points. The margin decline primarily reflected the impact of our net incremental RRP investments of approximately $600 million.

For reference, the factors mentioned previously for Japan and Argentina had an adverse combined impact on our currency-neutral adjusted operating income growth and margin of approximately 3.3 and 1.1 percentage points respectively.

Our adjusted diluted earnings per share of $5.10 increased by 8.1% driven by both a lower effective tax rate and net interest expense. Excluding adverse currency of $0.11, which occurred in the second half of the year, adjusted diluted EPS increased by 10.4%. The lower effective tax rate and net interest expense were both driven by the 2017 U.S.

Tax Cuts and Jobs Act. Our 2018 effective tax rate decreased to approximately 23%, slightly better than the 24% that we had assumed as part of our guidance in November and around 5 to 6 points below our effective tax rate in the years prior to tax reform.

The decrease in net interest expense resulted from greater flexibility on cash repatriation and capital structure optimization provided by the reform. Our operating cash flow of $9.5 billion increased by over $500 million, or 6.4% principally driven by higher net earnings partly offset by unfavorable currency.

Capital expenditures of $1.4 billion came in below our full year assumption, primarily reflecting continued improvement in heated tobacco unit investment efficiency as equipment productivity rises.

Turning now to market share, our total international share of 28.4% increased by 0.5 points, our highest organic growth since 2008 driven by heated tobacco units, which reached a share of 1.6%. Remarkably, share grew in all six of our regions, underlining the strength of our combined portfolio.

Our share of the international cigarette category was flat at 27.4%, demonstrating our success in maintaining cigarette market leadership while transitioning our product portfolio and transforming our overall organization.

Further, despite over-indexed IQOS out-switching and the impact of the sizable volume contraction in Saudi Arabia during the first half of the year, Marlboro’s international share of the cigarette category was also flat, reflecting share growth in a number of markets, including France, Indonesia, Mexico, the Philippines and Turkey.

With the performance of IQOS being top of mind for investors, let me also highlight some of the latest results and developments, beginning with an overall view, followed by some market specific commentary.

As seen on this slide, the total estimated number of IQOS users reached 9.6 million in the fourth quarter, continuing the positive quarterly sequential growth trend. Importantly, nearly 70% of the total, an estimated 6.6 million users, have already stopped smoking by switching to IQOS, while the balance are in conversion.

IQOS user growth in the quarter was especially driven by the EU region and Russia. Approximately 1/3 of the total IQOS user base is now in markets outside Asia, which highlights the broadening geographic success of the brand’s proposition.

As announced last year, we began the global launch of our IQOS 3 devices in mid-November, starting with our own retail and e-commerce channels.

Though still early as full device availability and expansion to our main distribution channels has only occurred in the past couple of weeks, we are very pleased with the initial consumer reaction to the new device lineup across IQOS markets. I will now turn to the performance of IQOS in specific geographies, beginning with Japan.

As discussed during our earnings call in October, there were sizable trade and consumer purchases of both cigarettes and heated tobacco units across the industry during the third quarter in advance of the excise tax-driven price increases on October 1.

This led to a distortion in heated tobacco unit in-market sales in both the third and fourth quarters. The same distortion is reflected in our share progression between the third and fourth quarter. When equalized for the purchase patterns, our estimated share in each quarter was approximately 15.4%.

Looking to 2019, we are encouraged that the favorable heated tobacco unit weekly off-take share trend that we observed during the fourth quarter continued in January. We anticipate increased competitive activity this year, including new heated tobacco product launches.

This may accelerate overall category growth, in part by reducing the consumption dilution observed with current competitive device ownership, which I will show shortly.

In this context, we believe that the new IQOS 3 and its continued superior sensorial experience in combination with the range of initiatives that we rolled out during the later part of last year, including the mid-priced HEETS brand, will allow us to restore growth.

Importantly, the convenience store channel, which accounts for the vast majority of our volume, began selling IQOS 3 and IQOS 3 MULTI as of last week. But already, IQOS 3 has significantly increased the number of new users acquired by IQOS compared to the 2018 monthly average prior to IQOS 3 launch.

Furthermore, the national rollout of the HEETS brand, which is currently only available in geographies with approximately 25% of the country’s tobacco consumers will begin in the coming weeks. We remain optimistic about the long-term growth potential of the heated tobacco category in Japan and of our brand specifically.

Japanese adult smokers continue to show a strong and growing interest in heated tobacco product as demonstrated by device ownership and past 7-day usage trend.

Based on the latest available data over 45% of Japanese tobacco consumers owned at least one device while over 40% reported using a heated tobacco product over the past 7 days, while these indicators of category interest are not yet fully reflected in the latest category share of consumption of around 23%, this is understandable for a couple of reasons.

First, switching takes time, with a lag between device purchase, use and the full conversion that maximizes heated tobacco share. This is easiest to see through the end of 2017, when IQOS was essentially the only product on the market at scale.

Second and more importantly, other heated tobacco product, which became broadly available over the course of ‘17 and ‘18 have been far less effective than IQOS in fully converting adult smokers. This is due to relatively low taste satisfaction, leading to mainly situational use that further dilutes the category share relative to device ownership.

Lower conversion effectiveness is also generating some hesitation among more conservative cigarette smokers to enter the category at this stage. Many users of competitive devices have never tried IQOS, and certain IQOS users also own a competitive device. Both groups represent great opportunities for us, with IQOS 3 and IQOS 3 MULTI.

Over time, as competitive products improve and more heated tobacco users experience the relative benefits of IQOS, particularly those who began their heated tobacco journey with a competitive product, we expect the gap between total category share and the level of device ownership to narrow.

Turning to Korea, fourth quarter share for HEETS of 8.5% increased by 3 points compared to the same period in 2017 or by 1.1 points sequentially, it should be noted that our share in the quarter was distorted by trade inventory movements ahead of the change in health warnings on heated tobacco products in late December.

We are pleased with our share performance, particularly given the backdrop of additional competitive activity in the heated tobacco category as the year progressed as well as the confusion among some adult smokers caused by the Korean FDA’s comments last year regarding the tar generated by heated tobacco products.

In-market sales volume for HEETS increased slightly on a sequential basis to 1.5 billion units. Looking to 2019, IQOS remains the preeminent brand in the category, with HEETS holding over 75% category share in the fourth quarter.

This position has been reinforced by the launch of our new devices, giving us confidence in our ability to grow HEETS volume and share further.

In the European Union Region, fourth quarter share for HEETS reached 1.7% of total cigarette and heated tobacco unit industry volume, an increase of 1.1 points compared to the fourth quarter of 2017, supported by all IQOS markets. On a sequential basis, share growth accelerated in the quarter, increasing by 0.5 points.

It is worth noting that IQOS is only present in geographic areas representing approximately 47% of industry total volume in the region. The favorable share momentum reflects continued growth in the total number of IQOS users, which reached nearly 1.8 million by year-end.

Importantly, as of late January, IQOS 3 is finally fully available in essentially all IQOS markets across the region. Our HEETS share growth in the EU region was driven by a number of markets, notably Greece, Portugal, the Czech Republic, Italy, Poland and Germany. As we have said before, the speed of IQOS adoption will vary by market.

This reflects factors such as the underlying disposition of adult smokers to use and recommend innovative tobacco products as well as the regulations that apply to reduced-risk products, such as those that impact our ability to communicate to adult smokers about better alternatives to continued cigarette smoking.

Despite related constraints in certain geographies, IQOS is growing across all EU launch markets, and the fourth quarter accelerations are going well for 2019. In Russia, the strong sequential performance of IQOS continued in the fourth quarter, with HEETS market share up by 0.7 points to 1.8% of the total number of IQOS users, reaching 0.8 million.

This performance is impressive given the fact that IQOS is present in only 7 cities, where the average fourth quarter share for HEETS was nearly 8%, with share in Moscow approaching double digits.

This primarily reflects increased adult smoker interest in and understanding and acceptance of IQOS as well as our targeted approach to geographic and channel expansion, which has underpinned an improvement in IQOS conversion rates and consumer experience.

Given our success in the existing large cities, we are now expanding into additional geographic areas. Before I turn to our 2019 outlook, let me remind you of the 3-year financial growth targets that we outlined during our Investor Day last September.

For the 2019 to 2021 period, we are targeting currency-neutral compound annual growth of at least 5% for net revenues and at least 8% for adjusted diluted earnings per share.

As detailed in today’s press release, we have adjusted the formulation of our annual EPS guidance to reflect the difficulty in determining with precision the speed at which adult smokers will adopt reduced risk products.

At the beginning of each year, we will now forecast our annual reported diluted EPS and the related currency-neutral adjusted diluted EPS growth rate by reference to a minimum threshold of expected performance. As each year unfolds, we intend to provide greater detail.

For 2019, we forecast reported diluted earnings per share to be at least $5.37 at prevailing exchange rates compared to reported diluted earnings per share of $5.08 in 2018.

Excluding an unfavorable currency impact at prevailing exchange rates of approximately $0.14 per share, this forecast represents a projected increase of at least 8% versus adjusted diluted earnings per share of $5.10 in 2018.

Our 2019 forecast assumes currency-neutral net revenue growth of at least 5%, which includes an expected adverse impact of approximately 0.6 points due to the move to highly inflationary accounting in Argentina. We expect IQOS and heated tobacco unit volume growth, in particular, to be the key driver of this growth.

Combustible tobacco pricing will remain an important contributor, underpinned by the broadly rational tobacco excise tax environment and mitigating the impact of the anticipated combustible product volume decline. As noted earlier, we recorded an exceptional pricing variance in 2018 that creates a challenging pricing comparison this year.

We expect our average pricing variance over the 2018 and ‘19 2-year period to be in line with our average annual pricing variance from 2008 to 2017. We anticipate the total cigarette and heated tobacco unit shipment volume decline of approximately 1.5% to 2% in 2019.

This compares favorably to an estimated total industry decline of around 2.5% to 3% for the year. Given the challenge of forecasting with precision heated tobacco unit shipment volumes, we are not providing a specific 2019 target at this early stage of the year.

That said, we expect positive volume contributions from all IQOS markets in 2019, and we remain confident in our shipment volume target of 90 billion to 100 billion units by 2021.

Turning to our cost base, our efforts to deliver over $1 billion in annualized cost efficiencies by 2021 are already underway led by important initiatives related to productivity, zero-based budgeting, a project-based organization model and other cost reduction opportunities.

We expect our progress on this front to contribute to an increase in currency-neutral operating income margin of at least 100 basis points in 2019. We anticipate a full year effective tax rate of approximately 23% consistent with last year and a relatively stable net interest expense compared to 2018.

We are targeting 2019 operating cash flow of at least $10 billion subject to year end working capital requirements. We project total capital expenditures this year of approximately $1.1 billion reflecting further investment behind RRPs in particular to support our platform for e-vapor manufacturing capacity.

I will close our 2019 outlook with some comments on the first quarter. While we don’t provide quarterly guidance, I believe that it is appropriate to share some additional visibility related to pricing.

We currently anticipate reported diluted EPS of approximately $1 in the quarter or flat compared to last year, subject to the timing of commercial spending associated with some of our IQOS related projects.

Excluding approximately $0.09 of adverse currency at prevailing exchange rates, this represents a growth rate of 9% compared to adjusted diluted EPS of $1 in the first quarter of 2018, which itself included a positive contribution from currency of $0.03 or approximately 3 percentage points.

I will conclude with a few key takeaways from our 2018 performance. As evidenced by our total share growth internationally and our stable share of the cigarette category, we are successfully managing our transition from cigarettes to reduced-risk products.

Our combustible tobacco portfolio remains the foundation of our business and is delivering robust performance and pricing power. Furthermore, the international cigarette industry volume decline was broadly in line with historical trend.

IQOS continues to grow globally, nearly doubling heated tobacco unit in-market sales volume in 2018 and increasing the number of markets, making important contributions to its success. We estimate that as of year end over 6.6 million adult smokers around the world had already stopped smoking and switched to IQOS.

We estimate a retail value of approximately $18 billion for the combined heated tobacco and e-vapor category outside China and the U.S., with heated tobacco representing approximately 70% of the total. IQOS alone accounts for an estimated 57% of the combined retail value, with unit margins and switching rates superior to any other nicotine product.

We expect to increase our share of the e-vapor market through further development and deployment of our product portfolio. Turning to 2019, we anticipate better underlying business fundamentals, driving currency-neutral net revenue growth of at least 5%.

Our 2019 EPS forecast reflects a growth rate of at least 8%, excluding currency, compared to adjusted diluted EPS of $5.10 in 2018.

Finally, we remain confident in our strategy for a smoke-free future and are convinced that our RRP portfolio continues to provide us with a single largest opportunity to accelerate our business growth and generously reward our shareholders over time. Thank you for listening. Martin and I are now happy to answer your questions..

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

Hi, André. I actually first wanted to ask you about Altria’s decision to take a stake in JUUL. I would really love to hear your thoughts on this and if you think this was a good decision for them.

And also given the rapid growth of e-cigs in several markets internationally, would you guys consider some type of distribution agreement with JUUL? I think you will answer on you believe your technology is superior, but couldn’t there be a case for you to do both especially you are still not at a point really to fully rollout your technology?.

Well, I will start by reminding everyone that, because there is a lot of discussion amongst investors and in the media in general what is the potential of x product, y product, JUUL, IQOS and so on and we have to understand that this is not a binary or a zero-sum game or winner takes all kind of situation.

I think you can say there are some form of parallelism with intersections in the trajectory of consumers between e-vapor products, lighter-pure nicotine products and heated tobacco products.

We know that heated tobacco products have the highest conversion ability, but there are people that in markets where IQOS doesn’t exist, that have already switched fully to e-vapor products. And there are people that use both. So, we are going to see very different behaviors that are sometimes complementary and nonexclusive.

We will see we know that there is dual usage of e-vapor and cigarettes. We have people that may continue using the same amount, of cigarettes and have a few additional e-vapor products. And you will also see heated tobacco products, like IQOS and e-vapor, being used simultaneously.

That’s why we developed a portfolio of products that can cater to all consumers and that will see all kinds of combination going forward. So, we are ready to compete with everybody, and I think competition in the category and the ability to switch people out of cigarettes is very important.

I mentioned in my remarks, Japan, where we see that not subsidiary performing products in terms of sensory experience dilute the category, and we welcome products that can. So, I think, for us, as a matter of principle, there is room for all products, and there will be no one exclusive user of our competitor in any category.

So, I think we know sufficiently, and we have demonstrated over the past year that we understand all the categories, and so we understand all the consumers, okay? So, in our situation, to a certain degree, we’re not in the same market as Altria and I will not comment on the Altria decisions because they have to look at their own portfolio and situation.

And they took the decision to make the investment, which I respect. I think nothing has changed in the relationship we have with Altria in preparation of the IQOS launch in the U.S., and I think Altria confirmed that they are fully ready once we get FDA approval to go for IQOS. And we are looking forward to this moment.

As far as JUUL is concerned, clearly, JUUL benefits from a certain degree of awareness due to the U.S. market in certain English-speaking countries. So, we’ll see some initial success, for sure, because there is awareness as we had with IQOS, for example, in some markets when we entered, like Korea.

But then, we have to see the sustainability of the product proposition, both from a marketing and product performance point of view. But again, there is no one winner takes it all, okay? So, I think we have to go over this, this initial excitement and discussion, who is going to be the winning technology, who is going to be the winning brand.

I think there will be many brands. I believe IQOS is already a very well-established brand, as I said in my remarks.

If we combine the e-vapor and heated tobacco category, and the e-vapor category internationally is essentially in the EU and has been fairly stable, IQOS has 57% of the entire retail value of both categories combined, and we’re not even in the e-vapor category.

We plan to enter significantly the e-vapor category as of the end of this year, including with the devices we showed in Investors Day that are smaller devices to cater to different consumers’ needs. And that’s why we also said we increased a little bit the CapEx so that we have capacity to develop this to commercialize this product.

And I think we are ready for competing. The only thing I would say is JUUL, I hope they learned their lessons regarding certain undesirable target audiences that we are very careful and extremely wise about. And I hope that the Altria participation will increase their attention to unintended audiences. That’s all I have to say..

Now that was helpful. And then if I may, I wanted to ask a little bit more about the new innovation you just put into the market in November that you discussed a bit. But if you could drill down a little bit further for us and talk about if it did, in fact, meet your expectations or possibly exceed your expectations so far.

And then what will the rest of the rollout schedule look like? For instance, I think you’re still planning to do a phased rollout, but will the bulk of the new devices be in the market by the end of Q1, or is it by the end of Q2? And then last point on this, I’d like to hear from you just a little bit more about the cannibalization you might have been seeing.

You mentioned, I think, it’s been quite incremental, but I just kind of wanted a better understanding of that..

Okay. We’re talking about 2 different things, if I understand. The first is the rollout of what we call IQOS 3 devices and IQOS MULTI, and the other, what happens with the second lineup of consumables we have in Japan.

Is that correct?.

Yes..

Okay. So, a bit limited initially on IQOS 3 and IQOS 3 moved in many markets, so we made the product available only through our own retail and e-commerce. And we also made the product, so we had limitations, and I have to say we’re very pleased with the initial reaction.

People understand and appreciate also the IQOS MULTI because that was a clear consumer need. We have combined sales of both, and that’s very good. And we also continue selling IQOS 2.4.

So, although it’s a limited sample, I would say, because we are not national and in every retail channel with IQOS 3, the first indications is things are happening the way we had foreseen are happening. And the comments from the consumers are good.

And if you look at more to use Net Promoter Scores, we have improved also significantly the Net Promoter Score of IQOS in Japan, in particular, and in other places. And at the same time, we see new user acquisition, even with this limited availability of IQOS 3 increasing.

So, it’s early indications, but they are good indications, and we see the same in other markets. We’ll give a bit more color and granularity in CAGNY because we will have a bit more weeks behind us with full availability. But so far, so good. Now regarding HEETS, our reading is they help from the limited markets again we’re in.

They help increase consumer acquisition because we cater to people that are a bit more price-sensitive. We have incremental share if you combine both Marlboro heated units and HEETS in the places we were, and that’s why we decided to extend. There is obviously a certain cannibalization because we are, essentially, the only product.

But overall, we have share increase, and that’s the encouraging part..

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

So, André, I guess I wanted to ask a little bit more about the volume outlook for 2019. I know you’re not giving specific volume target for IQOS, but clearly, you’re giving the consolidated volume guidance of down 1.5% to 2%.

So, I think we can kind of back into what you’re, at least high level, expecting for IQOS if we assume combustibles down somewhere around 3%, 3.5%. So maybe a little bit more color just in terms of, at a high level, how do you see volume kind of playing out for IQOS and combustibles.

And then more specifically, in Japan, just based on JT’s comment earlier today that they’re expecting only 3% category growth for the heat-not-burn this year, I’m just wondering if you think that the growth rate could be more robust or is that kind of a more prudent assumption at this point in the year?.

Look, we see clearly growth in all the markets where IQOS is present, okay, volume growth. I mean, I would not read too much in the forecast of global combined cigarettes and everything because, frankly speaking, we were positively surprised last year by the combustible category as well with more positive volumes than we initially anticipate.

All I would say is we are in line with the projection I gave for 3 years down the line, 90 billion to 100 billion, and I would not venture in more precise volumes this year because they are baked in the, at least, 5% revenue growth, okay? In Japan, in particular, if you have noticed from the slides, I don’t know if you had the opportunity to see them, we see growth in the share of IQOS, actually in Japan, in January, the share of IQOS was 16.5%.

So that’s very nice compared to 15.4% we had in the previous quarters. I would not it’s in 1 month, and I would not read anything into this, but it’s a positive development. And EU and Russia, as you have seen, we have very positive trends. So, we are very optimistic, but we’ll keep you abreast on what’s happening as the year unfolds..

Got it. Okay. And then maybe just a little bit more specific to Russia because obviously, that’s one market where, clearly, you’ve seen improvement sequentially, both on the volume side and market share side.

I guess my questions are, number one, is that starting to have a bigger impact on the broader combustible category volume, certainly in markets like Moscow, where you’ve got a pretty sizable share with IQOS? And then just broadly speaking, as you kind of roll out IQOS into additional cities in Russia, kind of the cadence of volume trajectory that you’re expecting as you implement that strategy going forward?.

Look, I mean, as we expand in different cities, we’ll see additional volume, obviously. We also need to understand, we are in the richest and more affluent cities, and we see continued growth. As we expand over time, maybe the growth trajectories will be a bit slower because we are reaching lower-income consumers.

But overall, I think Russia piloted a number of practices, including using digital tools, that show that we can scale up efficiently without necessarily expanding manpower everywhere.

And that’s something, now that we have the digital platforms, as I said, and infrastructure available and we’re rolling it out as we speak, should be an accelerator this year and most importantly, in the years to come, with also much more cost efficiency underlying the growth trajectories of IQOS.

So, I see I mean, we’re very pleased with what’s happening in Russia. I think it’s a very clear demonstration that IQOS has potential everywhere, even in markets that have less purchasing power. And the testing of the tools show that we can scale with much more efficiency than before. So, it’s all very positive signs..

Got it. Okay. And then just my last question. Just in terms of your profit guidance or the operating margin being up about 100 basis points, it seems like that’s mostly around being the half of kind of the incremental spending that you put into place in 2018 kind of not growing again. So, I’m just curious if that’s sort of the correct interpretation.

And I know that IQOS has been pretty volatile just in terms of thinking about the profit performance.

So, when you kind of look at the 100 basis points operating margin target, how comfortable are you that you should be in position to deliver on that target even if volume slows or other things happen from an IQOS kind of volatility standpoint?.

Look, we are fairly confident we can then deliver on this. It’s a combination of, as we said, lower spending, much lower spending than last year, but still incremental spending. And the second one is an increased volume contribution of IQOS to the overall earnings. And as we know, IQOS has better margins. So that’s the way I would read it..

Our next question comes from the line of Adam Spielman of Citi..

Thank you very much so first, can I just follow up on the answer you gave to Judy, just to make sure I got it, absolutely right? With respect to the 100 basis points, it sounds like the majority of that is coming from the efficiencies of rolling out IQOS that you always said you were going to get.

And yes, we’re talking about the rise at the beginning of last year and less of it is coming from the new, relatively new use of $1 billion ZBB savings.

Is that the correct way of understanding that last answer?.

That’s correct. We started the ZBB project. But as you can understand, it’s not going to deliver big amounts of money in the first year because we have to go through the whole process and do it properly, okay? So, I see this participating as of the next year.

And we never said, just to be clear, that the $1 billion we are targeting is all money that you’re going to see on the bottom line, but you should see a portion of that to the bottom line. The other helps the incremental investment, so the deltas are not as big as they used to be in the previous year..

Okay thank you very much. So, the real question or the more important question is around IQOS. And I was surprised, frankly, how strong it was in this quarter relative to the third quarter. And I was just wondering if there were any shipping effects we should be calling out. Clearly, Japan was harmed by shipping effects.

You called out a positive one in Korea.

But for example, in Italy and in Russia, where there any shipping effects that somehow artificially boosted your IQOS volumes?.

Okay. There were, some shipment in Russia ahead of we’re expanding in different cities.

So, there is its preparation of the expansion, okay? I don’t remember exactly how much that was, around $1 billion, $0.8 billion, something like that, if I can recall correctly, okay?.

It was planned..

It was planned from the beginning, so it’s not something but there is nothing else in there.

The rest is direct in-market sales, okay?.

And so, for example, if you will focus just on Italy, there was a huge jump in market share in Italy in 4Q, even relative to 3Q.

I was just wondering if you can explain what caused that and how we should think about it going forward as well?.

That’s a very good question. First of all, I think we see momentum in Italy. It took a lot of time, if you remember, Adam, to get Italy moving given the restrictions.

And I think it’s just the fact that there are more consumers of IQOS in Italy, so start having word-of-mouth, okay? Again, I wouldn’t read 1 quarter as the proxy for the acceleration, but the momentum is there. So, I think, in Italy, finally, we start seeing this better than slow linearity of growth, and that’s exactly what’s happening.

And this is ahead of us deploying further of the efficiency tools I described. But this is what you read in Italy, share of the market. It’s nothing to do with inventories and shipments and all these things..

Perfect. And then one final question for me. And this is about the guidance. Am I correct to understand, you’re giving guidance in sort of 2 different sorts of ways, firstly, you’re giving floor guidance? So, it’s a minimum of 5% sales growth. It’s a minimum of 8% constant currency EPS.

But then when you’re talking about things like the volume, the combined volume figures, that’s more of an expectation. It’s not a floor. And is that correct that it’s more in the sense and the style you used to give guidance, that this is really what you expect to happen? And it might be a little bit worse, it might be a little bit better.

But the EPS isn’t really an absolute floor in terms of constant currency?.

Yes. I mean, look, volume for the year is a bit difficult to estimate. So, we gave a range of 1.5% to 2%, okay? That’s our estimate. It can come better or slightly worse. It depends on the combustible as well.

So, it’s just to give you a flavor of what we see compared to total market, which means we expect share growth in this whole context, helped obviously by the IQOS units as well. But I mean, the key guidance is more than 5% and more than 8%, and that’s how it is..

Yes, at least..

All right?.

At least..

At least..

At least, yes..

Yes at least. And can I tempt you to sort of give a sort of offering so that you’d be really surprised if, let’s say, it was more than 12% on EPS? Or how big is that at least? I mean, how big is it? To me, it’s very conservative..

Well, as the year goes, I had I think depending on what happens, we’ll give you better forecast for the remaining year. I would stay to what I said at this stage, and that’s all I can tell you at this stage, Adam..

Thank you. I failed to tempt you. Thank you very much..

Our next question comes from Vivien Azer of Cowen and Company..

Hi, thank you. Good afternoon..

Hi, Vivien..

So, I wanted to follow up on the IQOS 3 launch in Japan, and I appreciate you want to hold some of this detail back for when we see you in CAGNY in a couple of weeks.

But can you offer any color around like the underlying consumer demographics of the new users that you indicated you’ve been acquiring? Is it kind of going deeper into that kind of first tranche of consumers, kind of younger, more affluent, or are you finally starting to see early success in terms of penetrating that 55 Plus market that had proven a bit elusive? Thanks..

Well, clearly, we made – first of all and foremost, we made these devices available as an option to existing users of IQOS, especially part of our, what we call the IQOS sphere and exclusive users, okay, because I think that’s fair to these people to have first access. But we also see now sales from people that have never bought IQOS before.

I don’t have the demographics to be fair with you – with me, but we’ll provide them in CAGNY.

And I would not like – I wouldn’t provide statistics just with 1 weeks or 2 weeks of rollout, okay? So, what I – I repeat what I said before, we also see sales of 2.4 Plus surprisingly because people knew that the new device is coming and still bought 2.4, especially the most price-sensitive consumers, which in my view shows that the strategy works and that there will be people that they will enter the category also through 2.4 Plus.

Don’t forget, we kept the previous version at a lower price and we sell the new devices at a higher price, so we have a dual strategy. And I think this in combination with the HEETS that are at a lower price than the Marlboro consumables are for IQOS, will help us increase the penetration of the more price-sensitive consumers, okay..

Okay. That sounds great and totally reasonable and I look forward to hearing more about that at CAGNY when you have more data.

My other question on the RRP category in Japan, just to kind of follow up on Judy’s question, I certainly appreciate your point that with a host of product activity from you and your peers that, that should engage more Japanese consumers.

The question though that I have is do you have adequately embedded in your guidance increased spend? I know you’ve got a really favorable comp, but given that you’ve got new products from a host of competitors hitting in 2019, how are you thinking about incremental investment spend in Japan specifically? Thanks..

Well, we have embedded overall, I would not make specific comments for markets, incremental spending. As I said, it’s much less than last year, but it’s still a lot of incremental spending and I think we’re adequately equipped to compete in Japan.

At the same time, as I said, we’re also rolling out digital tools and CRM platforms we didn’t have before. And that should help cause the retention, which we should not forget, including making existing IQOS users that own multiple devices to go back and exclusively use IQOS, which IQOS 3 helps significantly in achieving this.

So overall, I think we are in good shape. We knew the competition is going to come. And I think at the end of the day, a better product will increase the full conversion over time and then over time also, the best product will win. But as I said many times, we’re not going to have 80% of the segment forever in Japan.

What is important is that the entire category grows over time and I see no reason why the category will not grow. Every indication from what we showed is, is with the right product portfolio, the category will continue to grow..

Okay. Thank you very much..

Our next question comes from the line of Michael Lavery of Piper Jaffray..

Hi, Lavery..

Good afternoon. Thank you. You have several markets in Europe now that have around a mid-single-digit or even higher IQOS share. But typically, those countries still don’t have national expansions.

Can you give us both a sense of when that might come and also in some launch cities or launch areas, what the share might look like? If you’re giving to us now on a national basis, what does it look like where it’s a little bit more concentrated?.

Well, I mean, if I – as I said, if you take the European Union, we are roughly at 50%, 47% of volume-weighted, if you want, present. So, our share in the European Union would be double in the places where we are present, roughly speaking, okay, so it’s 1.7, I think it would be 3.4, okay, as….

Yes. I understand that math. I guess, more specifically, some of the places you’ve launched first like Milan, Rome, Prague, Athens, not necessarily first, but where there’s been either a longer history and/or a more rapid acceleration and better awareness.

What does the share look like in some of those places that are your better performers that when you give a national share, might be masked a little bit by places that – in that country you still haven’t launched yet or that have just – that are just getting started?.

Yes, look, I don’t have all the numbers. If I recall correctly, Athens is well above 10, because I know, it’s my home city, okay. Actually, yes, it is – the whole region of Attica, including Athens is 14% now, which is pretty high and growing. Milano, I don’t have it, if somebody can help me here..

Rome is about double the –.

Just 1 second. Milan actually is an interest experiment because it’s where we tried the first ways in the past. It was very flat, took us a lot of time to make consumers try the product again. But if I’m not mistaken –.

It will be in Milan or in Rome –.

Okay, sorry, but in Milan or in Rome, it’s 5.3, something like that, okay. We’ll give you bit more color in CAGNY on all this. But for me Milano is probably the most important because it is the most difficult city because of the previous presence of IQOS to regain momentum and we did. So that’s a very good sign, actually..

Okay. No, that’s very helpful. Thank you. And then just on your thoughts on more national expansions in any other European markets or you’ve already talked about Russia expanding a little bit more.

Is that one that you would expect to go national as well?.

Look we go gradually in most of the markets. As I said previously, our objective, I mean, we are at 43, call it markets today. The priority is to expand nationally to see the full potential in these markets, now that we can scale up efficiently.

And during the year, we may open new markets if there’s strategic opportunity or the regulation changes, but the focus is to expand nationally in the markets where we are and that’s what we are following, okay..

Okay, that’s great. And then just a little bit more of a housekeeping question, you talked about the 100 basis points margin expansion X currency.

Do you have any sense of what the transactional currency impact might be that we should have in mind or to factor in there?.

I have not – I don’t have the calculation, but traditionally, our transactional currency is 10% of the total currency impact. If I can use this as a rule of thumb, I don’t think it’s more than that..

Okay. That’s helpful. Thank you..

Our next question comes from the line of Pamela Kaufman of Morgan Stanley..

Hi. Thank you for the question. You made comments at the beginning of the call that the share price performance, which has partly been impacted by industry concerns that are more U.S.-specific.

I wanted to get a sense if this influences your view on timing for reinstating share buybacks?.

Look, we look at the share buyback regularly. And I think for the moment, the conclusion is that we follow the plan. I think Martin explained that if we look at the 3-year period including this year, it’s in the outer years that we will be in a position without losing our rating to restore share buybacks.

I understand it may be tempting for – to do this, but I think we have to stick to the plan because I believe that some of the impact on the shares as I explained is due to our lower-than-expected initially performance, but the reality is also there is a lot of uncertainty that I’ve been trying to clarify.

And we’ll clarify even better e-cigarette categories, e-vapor worldwide and heat-not-burn and all the interactions in CAGNY. I think it’s a necessary anxiety there. And in this context, I think for us, our focus is to deliver the results quarter-after-quarter and get the growth of the products.

And I’m sure investors will appreciate these and have the share going up rather than doing very opportunistic share repurchases rather than based on a clear plan when the time is right for them..

Okay. And you mentioned that combustible pricing would – should moderate towards more in line with the historical pricing growth in 2019.

What do you see as the puts and takes contributing to your outlook, and are you still anticipating a relatively benign excise tax environment this year?.

No, I think the excise tax – if you look globally, the excise tax environment is fairly stable. I mean, yes, there are occasionally, there are 1 or 2 markets that have more than regular increases. On the other side, we have the positive surprise of Indonesia, where the government decided not to increase excise taxes, okay, so which would help volume.

What I was trying to say in my remarks is we have to see 2018 as a very exceptional year because of Russia comparisons, that’s a major contributor to pricing, obviously, given its volume size. Russia 2018 comparisons were compared to 0 almost pricing in 2017.

Also in the Philippines, because the illicit trade went away, we had the opportunity to get very significant pricing in ‘18. Obviously, that would be more regular now that we rebased our pricing in the Philippines. So, the overall environment I think of pricing has not changed. It’s very robust. It’s there.

But all I said is we have to look at ‘17 – ‘18 and ‘19 as 2. And if you add the 2, we are very much in line with the rest, okay. And we have already taken 60% plus of the pricing so far. There’s still a few markets that the price tax situation has not settled, but this is not anything major. I think overall pricing is very much in place and intact..

Okay. And – thank you.

And just lastly, how is IQOS MESH performing? And can you provide an update on what progress you’ve made on your Platform 2 and 3 products and timing?.

Look, IQOS MESH is only in our own e-commerce and a few stores – actually, our own stores in London. For us, it was the experimenting again to see whether the flavors we offer are acceptable to consumers, whether the product itself is acceptable and then improve before we go for much more widespread expansion of the product.

So, it’s very difficult to judge what is the potential. I think we learn what we need to learn. Obviously, we’re there with the devices you’ve seen that caters more to the pod and mod, big vape or bigger vape consumers. In Investor Day, we explained to you that we have also smaller devices that cater to different consumers.

And we are investing in manufacturing capacity for those devices and related cartridges. Overall, I would say the consumer feedback we receive is very good. They recognize the product is better, much more robust, batteries, detection of end of liquid and all these things.

Now we need to integrate them in the smaller devices and that’s what we’re doing just now for rollout. P3 is a bit – we’re preparing the industrial designs for the product. The product is stabilized. Clearly here I see the potential more longer term and more situational use of the product, their full conversion at this stage.

So, it’s not something we roll out immediately, but all in very selected places in order to get better understanding.

And in Platform 2, which I think is very promising, as we know, we’re working on resolving one problem that in humid climates we had some problems with the heat source, that there were some fall-offs occasionally and that’s – even if it’s very small, it’s not acceptable. So, we are now working – I think we have a solution at lab level.

We’re working on how to industrialize the solution before rol-lout. So that’s where we stand on all this..

Right. Thank you..

Our next question comes from the line of Robert Rampton of UBS..

Hi, thank you for taking my question. The first question I have is you mentioned IQOS has better margin. Could you talk about which markets you’ve reached breakeven and in which markets or cities you’ve achieved profit per stick, which is equal or better to cigarettes? Thanks..

Well, IQOS in every market we’re in has better margins than cigarettes. As a matter of fact, there is no one single market where we have lower margin than cigarette..

Including acquisition costs and retention?.

Okay, we’re talking about marginal contribution here, okay. As we explained many times, in all major markets, clearly, we are breakeven or above. But it takes depending on the market and the difficulty of consumer acquisition based on the restrictions, we’re between 1 year to 2 years before we get to breakeven point, okay.

So that’s how I would read it. I think Jacek showed all the details during Investors Day on how to do it at different markets. But that’s the rule of thumb, if you wish..

Okay, great. Thank you.

And in terms of the upcoming menthol ban in Europe, how does – how is IQOS treated under that, and how are you guys thinking about that?.

Well, heated tobacco products are excluded from the menthol ban, so we don’t see a problem with this, of course, we need to maintain it. And for cigarettes, we are ready clearly to offer consumers some alternatives, but what we saw from markets where there is a menthol ban, nothing happened actually.

People switched to the same brands very often with different variants of the brand. So, I don’t expect any major thing to happen in Europe even with the menthol ban..

Superb. Thank you. And so my final question, in terms of the latest evidence on the IQOS quitting rates and human trials, could we get an update on that or is that something you’ll give at CAGNY? Thank you..

I don’t – nothing new in there. I mean….

Conversions..

Conversion rates..

Conversion rates are the same. And in terms of quitting rates, we don’t see any change in the trajectories in Japan, which is the biggest market. If you look at cigarette or IQOS, it’s – the advent of IQOS has not changed the trajectories of people quitting smoking.

So, I think we are on the right side there in terms of concerns of regulators and public health people..

Superb. Thank you very much..

And ladies and gentlemen, we have time for one more question. Our final question will come from the line of Gaurav Jain of Barclays..

Hi. Thank you for the opportunity. Your view on superiority of heat-not-burn over e-cigarettes is clear due to the high conversion rates.

Do you think regulators prefer e-cigarettes over heat-not-burn on the risk continuum of risk reduction, which is then getting reflected in higher excise taxes on heat-not-burn versus e-cigarettes in different markets?.

That’s a big question. I think in principle my belief has always been that this product should be not taxed at all, okay? I’m just trying to be real because a reduction of 95% or 98% is a humongous reduction, okay, if you talk heat-not-burn versus e-cigarettes versus everything.

Now we have to be also realistic, that’s why the – there will be some taxes. There are taxes on heated tobacco products, some countries tax e-vapor products because at the end of the day, ministries of finance need money. What is important is that there is a differential and substantial differential between the two.

And that’s something we have achieved so far in all the markets where IQOS is present. And I think that’s something that in the foreseeable future should be maintained. So now if we look at the two categories, as I explained, consumers will decide at the end of the day how they will behave. The important thing is they move out of cigarettes.

It’s – because the only way to achieve harm reduction in global is to have a very high degree of people switching out of cigarettes and sticking 100% to the product. So far, heated tobacco product has proven to be much more efficient in doing this, but also e-cigarettes played a role, and then there will be people that can use both.

And when we have nicotine products, maybe they use all three of them depending on the situation they are. So, you will have exclusive category users and you have dual category users as we can see already and that’s why there is room for everybody. On IQOS, we have various platforms under the IQOS brand.

We focused initially on the heated tobacco product because we thought and we have the proof that it has the highest efficiency. And now time has come for us to offer more products to consumers.

And as we explained also in Investors Day, eventually, we will also have a product that has – use the same device with different consumables, e-vapor, heated and potentially nicotine, so consumers have absolute choice without the hassle of changing devices all the time. Now that’s a bit more future music, but that’s where we go.

And I – that’s why I say there is room for all kinds of product in the consumer journey over the years and within a day. And that’s how I see the category..

That is very, very helpful. And if I can have a follow-up on this.

So, the guidance you have given for 2021 on IQOS volumes, does it include IQOS MESH volumes as well or that is just the heat-not-burn product in your view?.

Well, it will include eventually e-vapor products, but the essence of our projection was based on IQOS to be frank with you, okay. So maybe e-vapor will become incremental on top of this volume..

Okay. This is very helpful. Thanks a lot..

And that was our final question. I’ll now turn the floor back over to management for any additional or closing remarks..

Well, thank you very much for joining us today. That concludes the call. And if you have any follow-up questions, please contact the Investor Relations Group. Have a great day. Thank you..

Thank you, ladies and gentlemen. This does conclude today’s conference call. You may now disconnect..