Philip Morris International Inc

Good day and welcome to the Philip Morris International Second Quarter 2019 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Philip Morris International Management and the question and answer session. In order to ask a question, please press the star key followed by one on your touchtone phone at any time. Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community. I will now turn the call over to Mr. Nick Rowley, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2019 second quarter results. You may access the release on www.pmi.com or the PMI Investor Relations app. A glossary of terms, including the definitions for reduced-risk products, or RRPs, as well as adjustments, other calculations, and reconciliations to the most directly comparable U.S. gap measures are at the end of today's webcast slides, which are posted on our website. Unless otherwise stated, all references to ICOS are to our ICOS heat-not-burn products. Comparisons presented on a like-for-like basis reflect pro forma 2018 results, which have been adjusted for the deconsolidation of our Canadian subsidiary, Rothmans, Benson & Hedges, Inc., effective March 22, 2019. 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 review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. Now, my pleasure to introduce Martin King, our Chief Financial Officer. Martin?

Thank you, Nick, and welcome, ladies and gentlemen. Building on our encouraging start to the year, we delivered very solid performance in the second quarter, notably reflecting positive momentum for both our combustible tobacco and smoke-free product portfolios, and strong currency-neutral adjusted financial results. Key among our strengths in the second quarter was our volume performance. On a like-for-like basis, total shipment volume declined by 0.7 percent in the quarter and increased by 0.1 percent June year-to-date. This performance was better than we had anticipated, notably driven by the EU region. Heated tobacco unit shipment volume increased by 37% to 15.1 billion units in the quarter, driven by the EU region, the Eastern Europe region, and Japan. Second quarter net revenues increased by 9%, excluding currency, on a like-for-like basis, driven by higher HTU shipment volume and favorable pricing for a combustible tobacco portfolio. Our performance was flattered by the timing of pricing in certain markets compared to the prior year, which contributed an estimated two percentage points to net revenue growth. RRP net revenues reached nearly $1.5 billion in the quarter, or nearly 20% of PMI's total net revenues. ICO's devices accounted for approximately 14% of RRP net revenues compared to approximately 19% in the second quarter of 2018. We recorded a strong light-for-light combustible pricing variance of over 6% in the quarter, driven notably by Germany, Indonesia, Japan, the Philippines, Russia, and Turkey. We have recently increased our cigarette prices in markets such as Mexico and Ukraine which should further contribute to a positive pricing variance over the balance of 2019. On a currency neutral, like-for-like basis, adjusted operating income increased by 15.7% in the second quarter, while adjusted operating income margin increased by 240 basis points. The strong margin expansion was driven primarily by favorable geographic mixed related to HTUs, reflecting the increased contribution of volume from ICOS geographies with relatively high unit margins, notably markets in the EU region. Like-for-like adjusted diluted EPS increased by 15%, excluding currency, driven by our strong business performance. Our total international market share, excluding China and the U.S., increased by 0.1 percentage point to reach 28.3% in the second quarter. This growth was driven by heated tobacco units, which increased by 0.5 points to reach 2.1%, reflecting broad base share gains across the EU region and in Japan and Russia. In the markets where IQOS has been commercialized, our HTU brands recorded a total combined share of nearly 5% in the quarter, despite not yet being fully distributed in many of them. Our share performance for cigarettes in the quarter reflected continued adult smoker out-switching to IQOS, as well as an estimated adverse impact of approximately 0.2 points related to turkey. due to the timing of price increases vis-a-vis the competition. We expect our share performance in Turkey to improve over the balance of the year. Turning now to RRPs, we surpassed 11 million ICOS users as of quarter end. Approximately 70% of the total, or some 8 million ICOS users, have stopped smoking and switched to ICOS, with the balance in various stages of conversions. In the EU region, HEATS continued its sequential quarterly share growth, increasing by 0.3 percentage points to reach 2.4%. This growth reflects success across a broad range of markets with varying regulatory frameworks and adult smoker preferences. We have achieved significant progress with ICOs across the region over the past year, as evidenced by the HEATS market shares shown on this slide. This includes strong growth in some of our larger markets, such as Italy, Poland, and Germany, as well as even faster growth in other markets, such as the Czech Republic, Greece, Latvia, Lithuania, and the Slovak Republic. Heats continued its strong performance in Russia in the quarter, with sequential in-market sales growth of over 23% and national share of 2.9%. As a reminder, our first quarter heat share was flattered by the impact on the total market of seasonally lower cigarette industry volume. The in-market sales volume progression therefore remains a more realistic indicator of the brand's trajectory. For reference, we estimate a first quarter adjusted share of 2.3%, implying sequential share growth of 0.6 points in the second quarter. We continued our geographic expansion during the quarter and are now commercializing ICOs in cities representing an estimated 40% of the market by total industry volume compared to approximately 32% at the end of the first quarter. In Japan, our total share for heat sticks and heats increased by 1.1 points versus the second quarter of 2018 to reach 16.6%. further demonstrating that the initiatives we introduced during the second half of last year are paying off and driving a step up in our share performance. After adjusting for the impact of estimated trade inventory movements, which benefited our first quarter share this year, our share was stable on a sequential basis. We continue to anticipate greater competitive activity in the category as the year progresses. While this may increase competitive churn among adult consumers over the short term as they try new products, we ultimately view this as a positive development for the category overall and for ICOS in particular. As I will cover later in my remarks, we are investing behind further enhancements to the ICOS III device in 2019 to reinforce the brand's leadership position. Importantly, share for both the heated tobacco category and our heated tobacco brands continued to grow sequentially in the quarter, based on the latest consumer offtake share data. In Korea, the heated tobacco category continues to be highly competitive, particularly in the area of non-menthol flavors and related new taste dimensions. Share for heat declined by 0.7 points and was stable on a sequential basis at 7.3%. This performance was flattered by the impact of inventory movements as seen from the adjusted market share progression. We attribute the current share dynamics mainly to competitive churn as new devices and consumables from the competition have entered the market and experienced initial trial. We plan to broaden our portfolio of heats to better address the unique taste preferences of adult tobacco consumers in Korea. and have related launches scheduled for the second half of 2019. In addition, like Japan, Korea will be an initial focus geography for the upgraded ICOS III device. It is important to remember that, aside from Japan and Korea, our focus for ICOS across most launch markets remains targeted to key cities. These city-level shares compare very favorably to the corresponding national shares and provide an encouraging indicator of the greater opportunity that can come with broader focus and support in ICOS markets. Before closing on ICOS, I would also like to reiterate our excitement over the prospects for ICOS in the US. As a reminder, on April 30th, the US Food and Drug Administration confirmed that the marketing of ICOS is appropriate for the protection of public health and authorized it for sale in the U.S. We are excited to bring ICOs to the U.S. market through an exclusive license with Altria Group Inc., whose subsidiary, Philip Morris USA, has the market expertise and infrastructure to ensure a successful launch, beginning with the initial lead market of Atlanta, Georgia. Turning to our full-year outlook, we are raising our 2019 reported diluted EPS guidance at prevailing exchange rates to be at least $4.94. The 7 cents increase compared to our prior guidance on May 1st of at least $4.87 was driven by stronger business performance, primarily reflecting better shipment volume, and a tax benefit of 4 cents related to a reduction in estimated U.S. federal income tax on dividend repatriation for the years 2015 to 2018, partly offset by asset impairment and exit costs of approximately two cents per share related to a plant closure in Columbia as part of our global manufacturing infrastructure optimization. Our guidance continues to include an unfavorable currency impact at prevailing exchange rates of approximately 14 cents per share. with just one cent in the second half of the year. After excluding the 20 cents per share of reporting adjustments and tax items outlined on this slide, our forecast represents a projected currency neutral like-for-like increase of at least 9% versus our pro forma adjusted diluted EPS of $4.84 in 2018. Our increased guidance now assumes a total shipment volume decline of approximately 1% on a like-for-like basis versus a decline of 1.5% to 2% assumed previously. We continue to anticipate full-year HTU shipment volume broadly in line with our in-market sales volume, with any net inventory movements in individual markets essentially offsetting on an aggregate basis. For the industry, we now estimate a total volume decline in 2019 of approximately 2.5%, excluding China and the U.S., which is at the low end of the previously communicated decline range of 2.5% to 3%. Our increased guidance further assumes like-for-like net revenue growth, excluding currency, of at least 6%, compared to the assumption of at least 5%, and our prior guidance. We also now expect ICO's device net revenues to account for less than 20% of our total RRP net revenues in 2019. The change from the previously communicated range of 20% to 25% primarily reflects the favorable geographic mix impact related to HTU shipment volume that I noted earlier. We continue to anticipate a full-year light-for-light combustible pricing variance above 5%, supported by our June year-to-date variance of 5.2%. This positive top-line momentum provides us the opportunity to further increase or advance investment behind ICOs in order to accelerate product and commercial development expand distribution in both existing and new geographies during the second half of 2019, further enhance the ICOs III device in 2019 to reinforce the brand, and strengthen our category leadership as competition intensifies. Consequently, we now anticipate net incremental investments behind RRPs this year of approximately $400 million compared to our previously disclosed estimate of approximately $300 million, with the majority of the $100 million step up in investment expected to occur in the third quarter. We believe this increased investment will reinforce the positive momentum behind ICOs heading into 2020. Despite the increased investment, we are maintaining our assumption of currency-neutral adjusted operating income margin expansion of at least 100 basis points on a like-for-like basis. While we don't give quarterly guidance, I believe it is appropriate to provide some additional visibility on the third quarter in which we expect currency-neutral adjusted diluted EPS to be essentially flat compared to our pro forma adjusted diluted EPS of $1.35 in the third quarter of 2018. This estimate assumes a like-for-like currency neutral net revenue growth rate in the quarter, slightly below our full year assumption. As I noted earlier, compared to last year, our second quarter net revenue growth benefited from the timing of price increases in certain markets. And some of this benefit will be offset in the third quarter. We also face a challenging combustible pricing comparison versus the third quarter of 2018, our strongest quarter for pricing last year. Coupled with our top line assumption, our third quarter EPS estimate also reflects higher expected costs on a like-for-like basis. This is primarily due to our net incremental investments behind RRPs with about half of the full year total of approximately $400 million expected to come in the quarter. Turning to cash flow, we continue to anticipate full-year operating cash flow of approximately $9.5 billion, subject to year-end working capital requirements, as well as capital expenditures of approximately $1.1 billion. In conclusion, we're building upon our promising start to the year and delivering a very solid performance in the second quarter. the fundamentals supporting our strong combustible tobacco portfolio are intact. The favorable momentum for ICOS continues across geographies, further supporting our confidence in our HDU shipment volume target of 90 to 100 billion units by 2021. Finally, on a currency neutral like-for-like basis, we have increased our full year 2019 growth assumption for net revenues to at least 6% and our anticipated full-year 2019 growth rate for adjusted diluted EPS to at least 9%, further demonstrating our overall confidence in PMI's short and long-term growth prospects. Thank you. I'm now happy to take your questions.