Philip Morris International 2016 Annual Report THIS CHANGES EVERYTHING 2016 Philip Morris Annual Report_LCC/ANC Review Copy February 22 - Layout 2 We’ve built the world’s most successful cigarette company with the world’s most popular and iconic brands. Now we’ve made a dramatic decision. We’ve started building PMI’s future on breakthrough smoke-free products that are a much better choice than cigarette smoking. We’re investing to make these products the Philip Morris icons of the future. In these changing times, we’ve set a new course for the company. We’re going to lead a full-scale effort to ensure that smoke- free products replace cigarettes to the benefit of adult smokers, society, our company and our shareholders. Reduced-Risk Products - Our Product Platforms Heated Tobacco Products Products Without Tobacco Platform Platform 1 3 IQOS, using the consumables Platform 3 is based on HeatSticks or HEETS, acquired technology that features an electronic holder uses a chemical process to that heats tobacco rather Platform create a nicotine-containing than burning it, thereby 2 vapor. We are exploring two Platform creating a nicotine-containing routes for this platform: one 4 vapor with significantly fewer TEEPS uses a pressed with electronics and one harmful toxicants compared to carbon heat source that, once without. A city launch of the Products under this platform cigarette smoke. ignited, heats the tobacco product is planned in 2017. are e-vapor products – without burning it, to generate battery-powered devices a nicotine-containing vapor that produce an aerosol by with a reduction in harmful vaporizing a nicotine solution. toxicants similar to IQOS. A One of these – MESH – uses city launch of the product is new proprietary vaporization planned in 2017. technology. Note: RRPs (Reduced-Risk Products) is the term PMI uses to refer to products that present, are likely to present, or have the potential to present less risk of harm to smokers who switch to these products versus continued smoking. Product visuals in this report are for illustrative purposes only. 2016 Philip Morris Annual Report_LCC/ANC Review Copy February 22 - Layout 2 Dear Shareholder, 2016 was a pivotal year for PMI, reflecting exciting progress in our transformation from a cigarette company to one that is focused on Reduced-Risk Products. While our cigarette portfolio continued to drive our income growth, we began to see clear signs of the enormous potential for our RRP portfolio. Higher-than-anticipated cigarette industry volume Our other key international brands also grew declines in select markets had an adverse cigarette market share. L&M, the third-largest impact on our cigarette shipment volume and net international cigarette brand, excluding China, revenues. However, the combination of favorable increased by 0.1 point to 3.4%, while Parliament pricing and judicious cost management drove and Chesterfield each grew by 0.1 point to 1.6%. strong currency-neutral financial results and an Net revenues, excluding excise taxes, of increase in full-year adjusted diluted earnings per $26.7 billion declined by 0.4% versus 2015, share (EPS) for the first time since 2013, despite mainly due to an unfavorable currency impact continued currency headwinds. of $1.3 billion. On a currency-neutral basis, net revenues, excluding excise taxes, grew by 4.4%, 2016 Results driven by favorable pricing of approximately 6% Our cigarette volume of 812.9 billion units in of the prior year net revenues, excluding excise 2016 declined by 4.1% versus the prior year, pri- taxes, and the strong performance of RRPs. marily reflecting lower cigarette industry volume, Adjusted OCI of $11.1 billion increased by notably in the Asia Region. Some 40% of the de- 0.9% versus 2015. Excluding currency, adjusted cline in our cigarette volume was due to Pakistan OCI grew by a strong 10.3%, driven by higher André Calantzopoulos and the Philippines, where the volume erosion currency-neutral net revenues, excluding excise Chief Executive Officer was concentrated in low unit margin brands that taxes, and a favorable cost comparison versus had a limited impact on our bottom line. 2015, notwithstanding continued investment A portion of our cigarette volume decline was behind RRPs. Our financial results were strong also due to in-switching to our own HeatSticks across all four Regions, with currency-neutral from our cigarette brands. HeatSticks volume adjusted OCI growth ranging from 8.7% in the reached 7.4 billion units, which reflected our EU to 12.6% in Eastern Europe, Middle East & maximum manufacturing capacity for 2016. Africa (EEMA). Adjusted OCI margin increased HeatSticks volume would have been much by 0.6 points to 41.8%, or by 2.4 points to 43.6%, higher absent this capacity restriction, which has excluding currency, again with gains across all obliged us to limit IQOS device sales in Japan four Regions. since June. Adjusted diluted EPS of $4.48 increased by Marlboro cigarette volume declined by 1.4%, 1.4% versus 2015, despite a currency headwind due mainly to Algeria, reflecting significant adult of $0.46 per share. Excluding currency, adjusted smoker rejection of the 2.0 Architecture for diluted EPS increased by a robust 11.8%. Marlboro Round Taste. However, the brand’s Free cash flow(2) was stable at $6.9 billion, cigarette volume performance was positive despite unfavorable currency of $340 million. across many geographies, including growth in Excluding currency, free cash flow increased by Louis C. Camilleri the European Union (EU) and Asia Regions. 4.9%, driven by higher net earnings, partly offset Chairman of the Board Excluding Algeria, Marlboro’s total cigarette by higher working capital requirements. volume increased. In September, the Board of Directors ap- Our international cigarette market share, proved an increase in our quarterly dividend to i.e., excluding China and the U.S., declined an annualized rate of $4.16 per share, reflect- by 0.6 points to 27.9%, due primarily to low ing its continued confidence in our business price Fortune and super-low price Jackpot in fundamentals and future prospects. This marked the Philippines. Market share for our remaining the ninth consecutive dividend increase since brand portfolio was essentially flat. We recorded the company’s spin-off in 2008 and, since then, growing or stable market share in 17 of our top represents a total increase of 126.1%, or a 30 operating companies income (OCI)(1) markets. compound annual growth rate of 10.7%. Aggressive price competition in the low price We continued to access the capital markets (1) segment put pressure on our share in some at very favorable rates in 2016, raising $3.6 Operating companies income, or “OCI,” is defined as operating markets, such as Italy and the Philippines. billion over the course of the year and reducing income, excluding general corporate Marlboro continued its widespread cigarette the weighted-average all-in financing cost of our expenses and the amortization of market share growth last year, with increases total debt by 0.2 percentage points to 2.8%. The intangibles, plus equity (income)/loss in the EU, Asia and Latin America & Canada weighted-average time to maturity of our total in unconsolidated subsidiaries, net. Regions. Importantly, the brand’s cigarette share long-term debt stood at 10.6 years at the end (2) Free cash flow is defined as net growth in Asia was achieved in spite of the of 2016, essentially stable compared to the cash provided by operating activities impact of HeatSticks growth in Japan. prior year. less capital expenditures. 1 a year-on-year weighted-average industry 4.9% in the fourth quarter and an estimated basis, assuming full tax pass-on. 6.8% during the final week of January Robust Ex-Currency From a regulatory standpoint, the 2017, despite the limits we placed on IQOS implementation of the latest European device sales in response to HeatSticks’ EPS Growth Union Tobacco Products Directive (TPD 2) manufacturing capacity constraints. $4.1 $4.9(2) across the majority of EU member states Based on our initial market intelligence, was a significant development. Notable we developed and deployed an improved areas covered by the Directive include commercialization approach focused on health warning size, minimum pack size adult consumers’ understanding of the and the ban of characterizing flavors, albeit heated tobacco concept, commitment to the +126.1% +11.8% with a grace period for menthol products exclusive use of IQOS and a close follow-up $4.8(1) until 2020. While compliance with the new of the overall adult consumers’ conversion (1) $1.8 $4.2 regulations was a major undertaking from a journey. This led to full or predominant manufacturing standpoint, our organization conversion rates(4) of approximately 70% or handled the transition flawlessly. higher at the end of 2016. To date, we have Plain packaging continues to be one of launched IQOS in key cities in 21 markets the main long-term regulatory challenges across all PMI Regions and, by the end facing our combustible tobacco portfolio. of 2017, expect IQOS to be in key cities Following Australia’s example, France and or national in a total of 30 to 35 markets, 28 21 21 21 the U.K. have implemented plain packaging, subject to capacity. (1) Reported diluted EPS. (2) Reported diluted EPS, while Ireland, Hungary and New Zealand As a result of the significant growth in excluding unfavorable currency of $0.46 per share. have adopted plain packaging legislation HeatSticks demand, we have dramatically and are in various stages of implementation. accelerated our manufacturing capacity Legislative proposals for plain packaging build-up. We expect the annual production have been raised, or are actively being capacity of HeatSticks to increase from Nine Consecutive considered, in other countries.