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Executives

Nick Rolli - VP of IR and Financial Communications

Hermann Waldemer - CFO

Analysts

Jonathan Fell - Deutsche Bank

David Adelman - Morgan Stanley

Adam Spielman - Citigroup

Judy Hong - Goldman Sachs

Chris Growe - Stifel Nicolaus

Erik Bloomquist - JPMorgan

Thilo Wrede - Credit Suisse

Thomas Russo - Gardner Russo & Gardner

Philip Morris International Inc. (PM) Q3 2008 Earnings Call October 22, 2008 9:00 AM ET

Operator

Good morning and welcome to Philip Morris International's third quarter 2008 earnings conference call. Today's call is scheduled to last about one hour, including remarks by Philip Morris International management and the question and answer session.

(Operator Instructions). Media representatives on the call will also be able to ask questions following the conclusion of questions from the investment community.

I would now like to turn the call over to Mr. Nick Rolli, Vice President Investor Relations and Financial Communications for Philip Morris International. Please go ahead, sir.

Nick Rolli

Welcome. Thank you for joining us. Earlier today we issued a news release containing detailed information on our 2008 third quarter result. You may access it on our website at www.pmintl.com. As we take you through our results today, we will be talking about results in the third quarter 2008 and comparing them with the same period in 2007 unless specified otherwise.

References to market shares are PMI estimates based on a number of sources. Net revenues data exclude excise taxes. You will find a data table showing how we made adjustments to revenues and OCI for currency and acquisitions on the last slide of today's presentation which will be posted on our website.

Today's remarks contain forward-looking statements and projections of future results and I direct your attention to the Safe Harbor statement in today's presentation and news release for a review of the various factors that could cause actual results to differ materially from projections.

And now it is my pleasure to introduce Hermann Waldemer, Chief Financial Officer for Philip Morris International. Hermann.

Hermann Waldemer

Thank you, Nick. Hello, everyone. It is a pleasure to report excellent third quarter results in the present environment. We achieved cigarette volume growth of 4% and 3.2% excluding acquisitions. Net revenues of $7 billion were up 17.5% on a reported basis and 7.2% excluding currency and acquisitions.

Reported OCI of $2.9 billion increased by 16.7% and by 7.2% excluding currency and acquisitions. In spite of the foreseen skew in our marketing investments and expenses in the second half of the year.

Finally, reported EPS of $1.01 increased 23.2% and adjusted diluted EPS of $0.93 was up 19.2% versus the pro-forma adjusted base of $0.78 in 2007. These numbers track favorably to our mid-term to long-term targets which we shared with you in March.

Before I delve into more detail on these very strong results, let me first address the four key topics. These are currency, our geographic balance, our Canadian acquisition and our capital structure and liquidity.

In looking at currency issues, investors should remember that we are a global company with sales in some 160 markets and revenues in a wide variety of currencies. The most important of which are the euro, the Japanese yen, the Russian rouble, the Indonesian rupiah, the Mexican peso and Turkish lira.

This wide basket of currency means that there are often offsetting effect. Further more, while the euro is the most important currency in terms of revenues, we have significant offsetting costs in euros and Swiss francs.

During the third quarter, the overall effect of exchange rate movements was positive to the tune of $217 million on an OCI basis. The growing strength of our business as reflected in our quarterly results enables us to reaffirm our full year 2008 guidance for adjusted diluted EPS of $3.32 to $3.38 representing a growth rate of between 19% and 21%. At current spot rates, our results should come in at the lower end of this range which is in line with current consensus estimates.

During the quarter, we generated 28% of our volume and 44% of our OCI in the mature and stable EU region. Asia which has a mix of mature markets such as Japan and emerging markets such as Indonesia contributed 25% of our volume and 19% of our OCI.

The EEMA and Latin America and Canada regions which consist predominantly of emerging markets accounted for 47% of volume and 37% of OCI. We believe this represents the best geographic balance in the tobacco industry.

Furthermore, I would like to emphasize that in our key emerging markets such as Indonesia, Mexico, Russia, Turkey and Ukraine, we have continued to witness consumer uptrading to mid and premium priced products in the third quarter. Although, we cannot exclude an eventual impact of the global financial crisis on consumer behavior, we remain very upbeat about the future and the resilience of our business in these markets.

Our geographic coverage is being further enhanced by our successful acquisition of Rothmans Inc. in Canada. This acquisition is both financially and strategically compelling. It provides us with a strong position in one of the five largest international markets in which we have a limited presence. The investment of just over 2 billion Canadian dollars is expected to provide attractive returns going forward. Rothmans has a growing share of about one-third of the very profitable Canadian cigarette market, and is the leader in the fine cut market. As previously disclosed, the acquisition will be modestly accretive in 2009.

Following the announcement of the tender offer, we received some questions from analysts and investors regarding the litigation environment in Canada. Let me re-emphasize that we considered the issue of litigation very carefully before we made the tender offer. Our traditional defenses remain available and strong, including common knowledge of the health risks of smoking, absence of product defect, compliance with government policy, defense similar to preemption in the US and flowed statistical models to mention a few.

PMI's legal team under Chuck Wall has a vast amount of experience in this domain and we believe that the Canadian litigation environment is and will continue to be manageable. The Rothman stock was de-listed on October 20 and we now own 100% of the company. The Canadian business results were incorporated into the Latin America and Canada region as of September19, but were immaterial for Q3 results.

As you know, PMI has a prudent approach to its capital structure and our business generates a formidable cash flow, which underpins our healthy liquidity position in these turbulent times. Earlier this year, we successfully issued bonds for a total of $9 billion denominated in dollars, euros and Swiss francs.

Thanks to our strong credit rating. We have had an uninterrupted access to the Tier 1 commercial paper market. We have currently $1.4 billion outstanding at an interest rate of 2.4%, which is well below LIBOR. We have established a committed revolving credit facility of $6.4 billion, which remains undrawn.

The strength of our business fundamentals and our strong cash flows underlies the decision made on the 29 of August by our Board of Directors to increase the quarterly dividend by 17.4% to $0.54 representing an annualized rate of $2.16, which at the current share price represents an attractive yield of 5.1%.

Since May, we have spent $4.5 billion against our $13 billion two-year share repurchase program. We are well ahead of schedule, and therefore are in a comfortable position to appropriately and prudently balance our fourth quarter share repurchases with developments in the financial markets over the next few weeks.

In reviewing our third quarter results, let me first focus on the overall strength of our superior brand portfolio. Our cigarette volume reached 225.9 billion units, an increase of 4%. Excluding acquisitions, volume increased by 3.2%, which represents our best organic volume performance in many years reflecting continued consumer uptrading, new product initiatives and enhanced communication and consumer engagement activities.

More importantly, this volume growth was accompanied by higher pricing in most key markets, resulting in a 7.2% increase in net revenues excluding currency and acquisitions. The EEMA, Asia, and Latin America and Canada regions achieved strong organic volume growth while the decline in the EU region was broadly in line with the overall market decline.

The vast majority of our key brands including Marlboro had positive volume trends. Marlboro shipments volume increased in the quarter by 1.1% to 80.3 billion units. Marlboro shipments were up in all geographical regions except the EU.

Strong results were achieved in a wide variety of markets such as Argentina, Indonesia, Japan and Ukraine. Our innovative line extensions are helping to strengthen the vitality and overall equity of the brand. Marlboro Black Menthol, for example achieved a 1% share of the Japanese market in September. This is the best result in recent years for any new brand in Japan.

Despite some cannibalization, this launch enabled Marlboro to gain 0.4 share points compared to the previous quarter and PMI to reinforce leading position in the growing menthol in Japan.

Marlboro Filter Plus continues to grow and is being further rolled out geographically. For example, we have achieved a 3.1% share in Bucharest, a 2.1% share in Kuwait and 0.9% share in Moscow. With a strong skew towards young adult smokers which we define as smokers between legal age, minimum 18 and 24 years old.

Other new initiatives behind Marlboro include the further geographic expansion of the shorter Marlboro Intense, the introduction in Latin America of new Menthol variant and the launch in Poland of Marlboro Gold Edge, a super-slim variant.

Parliament shipments were up 15.8%, thanks to tremendous momentum in Korea, Russia, Turkey and Ukraine while Virginia Slims volume was 3.6% higher. We are further reinforcing Parliament in Russia and Ukraine with the launch during the fourth quarter of the Luxury Super Slims Parliament Reserve.

While Virginia Slims is benefiting from the growth of its UNO variance. Our two key brands in the mid-price segment are L&M and Chesterfield. While L&M continues to be an issue in Russia, the brand appears to have stabilized in Romania and Ukraine. Outside of the EEMA region, the volume of L&M grew by 3.7%, driven in particular by Germany where L&M is the fastest-growing brand in the market.

The growth of Chesterfield, which is generally sold at a higher price is more than offsetting the decline of L&M. Shipments of Chesterfield increased by 14.6% in the quarter driven by strong results, particularly in Italy, Russia, and Ukraine.

While we focus our efforts on the more profitable, premium and mid-priced segment, PMI also has three strong international brands in the low-priced segment.

During the third quarter, the combined shipment volume of Bond Street, Next and Red & White increased by 12.3%. In addition, our local heritage brands in such markets as Indonesia, Italy and Mexico are performing well.

Let me now briefly take you through the results and key developments in our four regions. Industry cigarette volume in the EU region is estimated to have declined by 1.2%. Our cigarette shipment volume decreased by 2.1% reflecting the total market decline, unfavorable distributor inventory movements in Italy and the timing of shipments in Spain.

Constant currency net revenues and OCI were both up 1% with increases across all major markets except the Czech Republic and Poland, which were impacted by the need to temporarily absorb excise taxes as well as the overall market decline in these two countries. We are particularly pleased by the progress in the very important German market where we gained share in both the cigarette and fine cut categories.

During the third quarter, we continued to achieve very strong results in the EEMA region with volume up 5%, net revenues excluding currency 14.9% higher and OCI excluding currency growing by 25.5%. These strong results were driven by continued volume expansion and an improved mix due to our strong position in the premium segment in Russia, Turkey and Ukraine. Higher prices further boosted our profitability in these key markets to record levels.

Cigarette shipment volume in Asia grew by 5.6% to 55.9 billion units with growth in Indonesia and Korea more than offsetting the impact of the market decline in Japan.

Net revenues, excluding currency were up by 7.8% and OCI excluding currency was 8.6% higher thanks to favorable volume, mix, and pricing. We are very pleased with our progress in Japan with sequential total market share growth and the strengthening of our leadership in the growing Menthol segment behind Marlboro Black Menthol, Lark Menthol X and Virginia Slims Noire.

Our shipments in Indonesia increased 2.2 billion units or 13% driven by the strong performances of Marlboro and A Mild as well as the timing of Ramadan which resulted in an estimated of 800 million units being brought forward from the fourth to the third quarter.

The other key highlight in Asia was Korea, where our shipment volume grew 28.1% and share was up 2.3 points. Latin America and Canada also had a strong quarter. Our cigarette shipment volume was up 6.5%, excluding acquisitions.

Net revenues, excluding currency and acquisition increased by 7.8% and OCI, excluding currency and acquisitions was up 4.2% excluding the $61 million distribution related charge in Canada. These strong results were driven by all our key markets and by Marlboro, the shipment of which were up 3.3%.

To sum up, our business in EEMA, Asia, Latin America and Canada are performing very well with strong volume growth and improved mix and higher prices and margins. The outlook for the EU region is expected to improve with pricing power remaining strong, enhanced competitive position notably in Germany and an end to the distortions in the Czech market.

Enhanced innovation is driving improved organic volume. We are on track with our productivity and selling programs. We have increased our dividend and continue to enjoy a strong balance sheet and healthy cash flows.

As you can see, we are delivering against the targets that we shared with you in March. We firmly believe that we're well placed for any potential future consequences from the current global financial crisis and to continue to deliver a superior performance for our shareholders. And I'll be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question is from the line of Jonathan Fell with Deutsche Bank.

Jonathan Fell - Deutsche Bank

I have a couple of questions actually. First of all, just to clarify your remarks on the buybacks. It doesn't looks though the current credit situation has impacted the repurchases to date, but it sounds like you are expecting in the fourth quarter that the rates will be lower than it's been.

Can you give us any sort of guidance at all on exactly how much lower the rates of repurchase will be? I mean is the question at the moment that you can't buy any back at all, or do you expect at least to be able to continue to do some once the closed period ends. Secondly, on EU, I mean if we were consistent in saying the outlook should improve next year and pricing is strong, how much of a concern is it in particular at the lower-end markets like France, Spain and Italy? If the industry doesn't move pricing up quite soon, governments might do it for you given the increasing holes in their budgets?

Hermann Waldemer

Okay. So let me start with your question to the share repurchase program. This is an ongoing program. We will keep ongoing with our share repurchase program. What I wanted to say is my remarks is that we are actually in the good and comfortable position, in that we are ahead of the schedule and that we now can simply watch and see what the financials and what the market situation is out there in the financial markets. I mean, we all have witnessed the turbulences up and down everyday. This is simply what we look for and what we watch out for, but let me put it this way.

A company of our strength with liquidity, our balance sheet is, of course, probably as always amongst the ones that can access those markets first. It's just we have the comfortable position of doing what's necessary and best for both the company and the shareholders. So that's on the share repurchase.

On the other question EU, yes, governments are also in budget season right now, but I can tell you that in neither one of the three countries that you quoted France, Spain or Italy, there is really a discussion out there about significant excise increases, so I don't see those, and I hope also that this won't change from here to the end of the year.

Jonathan Fell - Deutsche Bank

Well thanks.

Hermann Waldemer

You're welcome.

Operator

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

David Adelman - Morgan Stanley

Hermann ,first, just to be clear, there's still no change in the commitment to buy back $13 billion in your stock through I guess it would be March of 2010, correct?

Hermann Waldemer

This is correct. This is a $13 billion share repurchase program over two years.

David Adelman - Morgan Stanley

Okay. Secondly, Hermann, as it relates to emerging markets, I heard your comments in your prepared remarks, but did you see any change in the tone of business as you went through the quarter and came into October?

Hermann Waldemer

Look, no. I mean the thing is really, the down-trading that everybody is referring to, or is afraid of, we just have not seen that anywhere around the world. Really, you go to Asia, you go to Indonesia, where you have a 12% inflation year-on-year right now, volume are up 13%, Marlboro is growing share, A Mild is growing share in the market.

The only thing you eventually can see of course low price segments are growing as well. Maybe they grow a little faster than the mid and the premium segments, but they all grow. So there is no down trading there.

Russia, to go to a different part of the world, our volume is up 8%. Our shares are up, actually Parliament is up, Marlboro is up, Chesterfield is up, just L&M is down, but as the brand related question and not the down trading related question because smokers actually trade up, for example, to Chesterfield.

The same would be valid for the Ukraine. Or if you then go to Latin America, actually in Argentina where we have fantastic results and Marlboro being up, Philip Morris being up, the only brand that is down there is Next which is in the low-priced segment and Latin America overall I would call an uptrading environment.

David Adelman - Morgan Stanley

Okay and then Hermann, if you think about the potential risks in those markets, particularly as it relates to the results that you would demonstrate over the next quarter and year on a US dollar basis, what do you think of as being the principle risks for the delivery of US dollar profits out of those markets? Is it currency? Is it the local operating profit results? Is it the threat of excise in a weaker market? Is it stress on the distributors financially?

Hermann Waldemer

Well look, I think, I mean the key to everything I would say is that first of all we deliver on our constant currency targets and that's what we have done the last three quarters and that's what we intend to keep on doing. I think that's the key to it.

David Adelman - Morgan Stanley

Okay.

Hermann Waldemer

In those markets that you quoted, down trading I just gave you the answer, I haven't seen it. Our own financial strength is certainly untapped.

David Adelman - Morgan Stanley

Okay and then two other quick things, Hermann. Any update on the discussions within Japan on a potential substantial excise tax increase in that market?

Hermann Waldemer

No. There is actually not much news there. The 45 MPs which are working on that proposal. This is not the government. This is a partisan group of MPs working on that. They haven't come out even with their proposal yet.

David Adelman - Morgan Stanley

Okay. And then lastly, Hermann, on Rothman's. In terms of getting approval for that transaction, did you have to commit to any particular employment numbers or maintaining the plants for a certain period of time and will that adversely affect your initial intended returns?

Hermann Waldemer

Look, we will keep the manufacturing sites there and actually modernize them. So we keep those with pleasure. And we are very happy to have that excellent organization now within our company, within our family. So there is no issue from that side.

David Adelman - Morgan Stanley

Okay. Thank you very much.

Nick Rolli

Thank you.

Hermann Waldemer

Thank you.

Operator

Your next question is from the line of Adam Spielman with Citigroup.

Adam Spielman - Citigroup

Hello. It is Adam Spielman here.

Hermann Waldemer

Hi, Adam.

Adam Spielman - Citigroup

To be fair, a lot of my questions have been answered already, but just wondering about Jonathan's Fell's question in a little bit more detail. Bearing in mind, your balance sheet is so strong and bearing in mind the stock has fallen as much as it has, do you think there is any chance to actually accelerate the buyback program to take advantage of the low stock prices?

Hermann Waldemer

Look, I think I can only repeat what I've said before, that we are in this very comfortable position just so we can watch the situation out there in the financial markets and do the best thing depending on how those markets develop. It is just pretty much impossible to forecast these days what the financial markets are doing.

Adam Spielman - Citigroup

Thank you very much.

Hermann Waldemer

But we are and remain committed to our share repurchase program.

Adam Spielman - Citigroup

Thank you. I think another question if I may as well. This is regarding emerging markets. Obviously in the past year or two there has been quite a lot of consumer inflation in emerging markets. Maybe that's one of the reasons you have been able to put up your prices in Russia and Ukraine and similar. If inflation generally slows down, do you think that means to say that your ability to put up prices or brands like Marlboro in these markets will be reduced or do you think it's the general inflation level is in fact completely irrelevant to your business?

Hermann Waldemer

I don't think so. If you look into a couple of the key markets taking Indonesia as example, actually our price increases generally have been even below inflation there, so we didn't overdo it in those markets, and if you don't overdo it in year one, you don't regret it in year two, so I think we are well-equipped there.

Adam Spielman - Citigroup

So you continue to take pricing in the market like Indonesia or wherever you happen to choose even if inflation becomes less intense?

Hermann Waldemer

Yes.

Adam Spielman - Citigroup

Thank you very much.

Operator

Your next question is from the line of Judy Hong with Goldman Sachs.

Judy Hong - Goldman Sachs

Thanks. Hi, Hermann.

Hermann Waldemer

Hi Judy.

Judy Hong - Goldman Sachs

Hermann, I know you said in the third quarter, the operating profit ex-currency slowed down because of some of the timing issues. Is there any way to quantify how much of the timing related spending increases or expenses put a little bit of a damper in terms of the operating profit growth?

Hermann Waldemer

The specific marketing investments, which we have made in individual markets for competitive reasons, that number I really wouldn't want to give. It is clear and obvious that we have invested in Japan and we begin to see the positive effects of those investments. All that was from the very beginning included in our forecasts and again I would say if you compare our ex-currency results, and then you compare them to our mid to long-term guidance, we fare pretty well against those.

Judy Hong - Goldman Sachs

Okay. And Hermann, I know that you don't typically give guidance on following year until you report the fourth quarter, but just in terms of how you think about '09 at this point just given some of the economic conditions around the world? Obviously, you've got the currency issue and then offsetting that you still have the cost savings that are coming through. In '09, are you comfortable still looking at on a constant currency basis in line with your long-term targets?

Hermann Waldemer

Absolutely comfortable with our mid to long-term targets on a constant currency basis that we have given, yes.

Judy Hong - Goldman Sachs

Okay. And on currency, I think in the beginning you've talked about some of the offsetting factors. If you could just elaborate that and as we think about the currency impact in '09, how should we think about all those offsetting factors as well?

Hermann Waldemer

The start of course is that, yes, currency movements have a substantial influence on PMI's dollar results. The last time it has been unfavorable was actually 2006, where it was unfavorable with some $180 million, it was $470 million favorable in 2007, and now year-to-date we are favorable $750, but really and that's what I was referring to. Currencies, of course don't move all in the same direction. I mean the recent moves of the US dollar versus the euro, but on the other hand versus the yen is just a living proof of what I say. And we have many other currencies that we work in around the world and take.

For example, the Indonesian rupiah which actually was rather stable against the dollar with maybe 5% swing only. In the euro exposure, I believe sometimes maybe overestimated that we really have. I mean, of course just to take 46% of OCI, which is the portion of the EU as the exposure would be misleading because we have substantial euro expenses. For example, to make one example for product sourced out of the EU for the Japan market, so there is a substantial euro expense out there.

Secondly, and very important, we have very substantial Swiss franc expenses at the operation center here in Lausanne, at the R&D center also in Switzerland. You remember, our R&D expenses, they're on a yearly basis in the neighborhood of the equivalent of $300 million.

The Swiss franc is of course the currency strongly related to the euro, co-related to the euro. So here you have the further netting against the euro exposure. So, therefore the euro net income exposure is, of course substantially lower in percentage than the percentage of EU OCI compared to the overall OCI of PMI.

Judy Hong - Goldman Sachs

Okay. That's helpful. Thanks, Hermann.

Hermann Waldemer

You're welcome.

Operator

Your next question is from the line of Chris Growe with Stifel Nicolaus.

Chris Growe - Stifel Nicolaus

I have just a couple of follow-up questions for you. The first one is in relation to investors concerns and it is appropriate one about a trade down in whether it is an emerging markets or developed markets, could you tell us in this quarter how well premium versus say mid-tier versus the low end for your business?

Hermann Waldemer

Look, the overall segment, if you would try to really to go a little bit on the overall segment size that you have out there, then actually the premium segment and the mid-priced segment on a worldwide basis would be growing. So our latest internal estimate there would be the premium slightly growing to 26, a bit above 26% worldwide. I am talking now mid price with growth of a bit more than a percentage point to 29% in the neighborhood of 29% and the low actually being down to something like 1.5% to 44%. That will be roughly the picture that you see on a year-to-date basis out there.

So and then if you go a little bit into the regions if you like in EEMA and Latin America, they are clearly up trading to mid and premium and I would say there was some talking about down trading in the EU. I think that has never happened. What actually has happened, the consumers were down traded by some companies via the repositioning of their brand to the low price segment.

Chris Growe - Stifel Nicolaus

That's actually very helpful. Thank you. Then, I wonder if you could say if there has been any difference between consumption and shipments in any of your major markets. I think of Russia, for example, where you could have wholesalers working through inventory and not repurchasing as quickly. Are you seeing that now in any major markets?

Hermann Waldemer

No. I mean, the only really meaningful impact is the one that I quoted on Indonesia where just because of the timing of Ramadan we had this 800 million, but I mean in terms of really our trade bringing inventories down or even up, I mean you can argue it either way. No, I am not seeing that.

We are actually watching that also quite closely. Look, if you take out trade receivables at the end of September, that would be $2.3 billion. Our top 50 customers around the world are 90% of that. So we of course follow them individually and closely. There are credit limits in place with every one of them and in this industry and in particular in our company, we have short payment terms. Ours are under two weeks.

Chris Growe - Stifel Nicolaus

Okay, that's great. And my last question for you is if you can give us any kind of update on the progress that occurred in the quarter in China, as well as the joint venture you have operating outside of China and that's fully operational there and especially in Europe?

Hermann Waldemer

Okay. Look, I mean Marlboro is up and running. On August 7, the locally produced Marlboro was launched in China. In terms of the international joint venture, we have essentially now launches in all three price segments. In the low segment that is RGD. It has a launch-to-date market share in the Czech Republic of 2.6%, in Slovakia of 1.1%, Poland of 0.7%, so going very well.

Dubliss, which is manufactured in our [Rizora] factory is a mid-priced brand which was launched in two cities in Russia and two regions in the Ukraine. Well, that launch is too early to give shares, but that's working fine. The latest news is that actually just a week ago or so we launched the first premium brand which is Harmony in Argentina. It is actually launched at the price of Marlboro, a premium cigarette, there is a touch of the orient. So you see we also go for the premium segment and for the most difficult launches in that joint venture and it is going well. We're very happy, we're making progress every day.

Chris Growe - Stifel Nicolaus

It is only if you're in about maybe six markets and that's what if I am correct, where you want to be by the end of the year, are there other market shares you're looking to launch into?

Hermann Waldemer

This year no. Other markets going forward, of course, yes.

Chris Growe - Stifel Nicolaus

But in 2008, no?

Hermann Waldemer

In 2008, we are done.

Chris Growe - Stifel Nicolaus

Okay. Thank you very much.

Hermann Waldemer

You're welcome.

Operator

Your next question is from the line of Eric Bloomquist with JPMorgan.

Erik Bloomquist - JPMorgan

Hi, Hermann and Nick.

Hermann Waldemer

Hi, Eric.

Nick Rolli

Hi.

Erik Bloomquist - JPMorgan

Just wanted to follow up on a number of things. Firstly with respect to the cost savings, you said that you were on track. Can you give us any more detail on approximately how far along we are in the cost savings and reconfirm the potential timing of the savings over the next three years?

Hermann Waldemer

Okay, look. I just went through that some ten days ago. Yes, we are on track to deliver the 1.5 billion and we will deliver the first 500 million this year, The things are on track. We had the US volume transfer over to Europe. Remember I'm still in 2007. There were about 57 billion cigarettes produced by PM USA for PMI, all that has been absorbed and still produced about 25 billion this year for us.

It has happened now. The financial service centers are up and running and delivering very nicely. So, all the programs individually are on place. You have swings between one and the other, but if you add it up, you're right there.

Erik Bloomquist - JPMorgan

Secondly then, I was wondering if you could comment a little bit on the outlook for leaf costs. Again, coming back to March, that was expected along with other raw material costs to be about a $500 million drag, and of course with US dollars strength that means I suspect that leaf costs may be somewhat declining. Can you talk about the overall outlook for that and then, as a secondary issue, could you talk about the issue of having to provide financing performers to grow the leaf and if indeed that's something we should start to try and factor, as we're thinking about the cost base for PMI?

Hermann Waldemer

Okay. On the lease situation overall, for the 2008 situation, and I am comparing with 2007, we have about P&L impact year-to-date of $90 million, something like that, but you have really to put that into perspective. You remember that typically you have three crops going into one blend.

The total leaf costs that you see on a yearly basis is about $3.2 billion, so we talk about an increase eventually of 5% of the leaf costs for this year, and then again I would like to put it into the context of the total cost of goods sold which for the year is in the range of $9.5 billion. So therefore, $90 million or $150 million for the year for increased leaf in relative terms, something that you simply have to live with.

Leaf prices in the year 2008, yes, they have gone up quite a bit. The cost of a kilo was up 15% to 20%. And what you already see now is the cyclical effect that the next harvest is already expected to be larger, so the supply is being expanded. If the seeds are in the ground now we know that, that the next harvest is going to be bigger and then of course you also have the currency effects, the dollar on one side.

But on the other side, also the Brazilian real because underlying, although the leaf is denominated in dollar, there is an underlying Brazilian real impact in there. So, on the overall outlook for the three years to be seen, it could be somewhat higher between a 100 million and 200 million to compare to the number that we had at the beginning.

However, let me emphasize there, that definitely has no impact on our mid-term to long-term guidance. That will be absorbed either through additional productivity or the revenue line or we will see and that's why I gave you the other numbers to put it into context and into the proportion.

Erik Bloomquist - JPMorgan

Thanks.

Hermann Waldemer

The question of financing of a farm. That has always been part of the program of us with the leaf dealers that farmers are being helped. So that is nothing new at the end and therefore nothing new that you need to factor in.

Erik Bloomquist - JPMorgan

Okay. And there is not a risk of the leaf dealers being squeezed and that some of that financing having to move to reside with the manufacturers in your view or with PMI?

Hermann Waldemer

Well look, that is rather really the question of the financial crisis, is that having any impact on key suppliers. I mean the way we work with key suppliers is that in the case of leaf, we of course have commitments to them. They know roughly what we are going to buy, so that is much more foreseeable for them than for say, the supplier of a car manufacturer which not only has to suffer his own financing problems eventually, but also a much reduced demand by the car manufacturer.

Our business is stable in that sense. Our volumes are stable or growing and therefore plannable. At the same time we of course have a principle on all major materials in place that we have, at least a dual sourcing for key ingredients, filter top will be the other one. We actually have four key suppliers around the world. So, yes, we're watching that, but it is all manageable as much as we can see.

Erik Bloomquist - JPMorgan

Okay. Super. Lastly, it seemed to me that looking at the underlying volume trends in key West European markets like Italy, Germany, even France, Spain, that the environment looking pretty good for future price increases. Is that a fair assumption?

Hermann Waldemer

I will not comment about future price increases. I am sorry.

Erik Bloomquist - JPMorgan

Okay. Thank you.

Hermann Waldemer

You're welcome.

Operator

We will now open the call to our media representatives. (Operator Instructions).

Your next question is from the line of Thilo Wrede with Credit Suisse.

Thilo Wrede - Credit Suisse

Good morning. I am Thilo Wrede here.

Hermann Waldemer

Good morning.

Thilo Wrede - Credit Suisse

The first question and just a housekeeping question. What would you consider your normalized tax rate for the third quarter?

Hermann Waldemer

Our ongoing tax rate is between 29% and 30%.

Thilo Wrede - Credit Suisse

Okay because you had a few factors that impacted the tax rate this quarter?

Hermann Waldemer

Yes, there are always one-time effects that can happen, but the ongoing rate is between 29% and 30%.

Thilo Wrede - Credit Suisse

Okay. Great. Then looking at the EU market, with the continued down trading there, how do you see the future of Marlboro in that market?

Hermann Waldemer

Look, in my opinion really and I am convinced about that, there is no and there has not been a down trading in the European markets. What has happened in Western Europe is that a number of brands, competitive brands that had been in the premium or in the mid-priced segment were repositioned to the low-priced segment which as we both know is not that far away.

In Germany, you talk about the price gap of $0.40. In Italy, you talk about $0.70, Spain would also be $0.70. So it was really consumers being down traded and not consumers down trading. There is a big difference in my opinion. In the EU and maybe there, take the German situation. Yes, Marlboro has been under pressure because of the reason that I was just quoting, and we are working on it.

This is what we have to answer and what we are answering with our product innovation, with our refilling of the pipeline, with our focus on the brand and we clearly can see, for example, in the key German market that, yes, Marlboro is still declining, but at a much slower pace.

This is very much improving, and we will keep on working to get that even better, nevertheless let me say also in the German market we talk about 24% of market share from Marlboro today. So is not that bad and at the same time what we of course in such a situation had to do and our German team did an excellent job there, is you have to answer the challenge and the answer was L&M which is now the fastest growing brand in the market.

Which is year-to-date up more than 2 share points to 6.8% and has a young adult smoker share of 10% and now we don't go just the cheap way again. No, we bring out L&M Night as an image version if you like of the L&M brand at the $0.10 premium to the regular L&M. That's how we tackle those situations and I have full confidence that we will keep on being successful there.

Thilo Wrede - Credit Suisse

Yes, that was helpful. Since you mentioned Germany, I am getting the impression that there are efforts going on in that market to repeal some of the smoking bans there. Is that something you are seeing? What's the outlook for the smoking bans in that market?

Hermann Waldemer

Well, okay, there is some easing due to recent election results in some states, to some court cases. Overall it will be eased. It will be a bit more consumer friendly or smoker friendly I would say. However, overall in the long-term, I don't expect a reversal of public smoking bans. I would just expect a more smoker friendly implementation of those public smoking bans.

Thilo Wrede - Credit Suisse

Okay. And then, last question on the Czech Republic. How much longer will the trade inventory movements there impact your results in that market?

Hermann Waldemer

Okay. Actually I would hope the mess is behind us there. So, by now I would say 90% to 95% of the products out there are in the market now at new prices. So finally almost one year after the last brands have come in with the new prices.

Going forward therefore I really expect now a situation that it is coming back to normal. The good news in the Czech Republic is that there is no excise tax increase foreseen in the budget bill. It is going to be voted in November, but there is no excise increase foreseen there.

I would say we are then in a normal environment well-positioned with a very strong and very broad portfolio covering actually all the price clauses covering international and local brands that we should be able to recover some of the positions that we have lost due to this unfortunate forestalling in that market.

Thilo Wrede - Credit Suisse

All right. Thanks a lot, Hermann.

Hermann Waldemer

You're welcome. Thank you.

Operator

Your next question is from the line of Thomas Russo with Gardner Russo & Gardner.

Thomas Russo - Gardner Russo & Gardner

Hi, Hermann.

Hermann Waldemer

Hi, Tom. How are you?

Thomas Russo - Gardner Russo & Gardner

Hi, Hermann. Two questions. First, what steps helped drive Korea so sharply up this year?

Hermann Waldemer

Innovation, our team in Korea is doing a fantastic job there. Really Parliament is on fire. Marlboro is doing very well, so we think this is really product innovation, excellent marketing, excellent sales in their true success story from that point. So this is neither pricing nor excise. This is a true marketing and sales success story.

Thomas Russo - Gardner Russo & Gardner

Terrific. And then in both the quarter and the nine months, you continued to spend quite substantially on marketing, the [lime] marketing administration and research, so for the three months at least it was up almost 30%. What is behind that? It's up to 1.5 billion versus 1.1 billion in prior year?

Hermann Waldemer

Okay. The numbers I don't have in front of me, but there must be some currency effect there, I guess.

Thomas Russo - Gardner Russo & Gardner

Yes.

Hermann Waldemer

There is reinvestment in there as we have said and the skewing of expenses really towards the second half of the year. You can see that our innovation pipeline which needed to be refilled has been refilled and now we are going out with all of these launches. You see the success on the revenue and on the volume side, but of course it doesn't come without investment.

Thomas Russo - Gardner Russo & Gardner

Thank you.

Hermann Waldemer

You're welcome.

Operator

Your final question is a follow-up question from the line of Chris Growe with Stifel Nicolaus.

Chris Growe - Stifel Nicolaus

Hi, Hermann. Thank you for the follow up.

Hermann Waldemer

Sure.

Chris Growe - Stifel Nicolaus

The only question I have is there was a $61 million one-time item in Latin America that it looks like you're including in your $0.93 if you will of operating EPS, is that correct? That is one-time in nature, though, correct?

Hermann Waldemer

Yes that's right. Distributed terminations happen from time to time in the business. That's why such a charge is in underlying and not just in reported.

Chris Growe - Stifel Nicolaus

Okay. And if that's not there the next year you have that benefit then with your Latin America division in the third quarter?

Hermann Waldemer

That's true. Yes.

Chris Growe - Stifel Nicolaus

That's all I needed. Thanks so much.

Hermann Waldemer

Okay. You're welcome.

Operator

I would now like to turn the call back over to Mr. Nick Rolli for any closing remarks.

Hermann Waldemer

Okay. It is still Hermann. I would like to make one last remark before we conclude this call. In these difficult times for the worldwide economy, no business in the world is actually recession proof, but I am convinced that our business is very recession resilient. There is no replacement product to cigarettes and our smokers are very loyal to our brand. Nick?

Nick Rolli

Okay, Hermann. Well thank you very much. As we did in the second quarter, the Investor Relations team is available in Lausanne and you could follow up with any questions. The phone numbers are posted on the website and also on our press release. Thank you again for joining us on this call. Have a great day.

Operator

Thank you for participating in today's Philip Morris International's third quarter 2008 earnings conference call.

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