Philip Morris International Inc

Good day and welcome to the Philip Morris International second quarter 2021 earnings call. Today's call is scheduled to last about one hour, including remarks by Philip Morris International management and the question and answer session. In order to ask a question, please press the star key followed by the number one on your touch tone phone at any time. Media representatives on the call will be also be invited to ask questions at the conclusion questions from the investment community. Now I'll turn the call over to Mr. Nick Rowley, 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 2021 second quarter results. You may access the release on www.pmi.com. 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 and additional heated tobacco unit market share data are at the end of today's webcast slides, which are also posted on our website. Unless otherwise stated, all references to ICOS are to our ICOS heat not burn products. All references to smoke-free products are to our RRPs. Growth rates presented on an organic basis reflect currency neutral underlying results. Adjusted net revenues exclude the impact of the Saudi Arabian customs assessments as described in today's press release. Please note that due to UK takeover code requirements, we do not intend to provide further information on this call regarding our offer to acquire Vectura Group PLC that has not already been disclosed in the Rule 2.7 announcement on July 9, 2021. A copy of the Rule 2.7 offer announcement is available on www.pmi.com. 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. Please also note the additional forward-looking and cautionary statements related to COVID-19. Now, my pleasure to introduce Emmanuel Babot, our Chief Financial Officer. Emmanuel.

Thank you, Nick, and welcome, ladies and gentlemen. I hope everyone listening to the call is safe and well. Our business delivered a very strong performance in the second quarter of 2021, coming slightly ahead of our expectation to match Q1's record high quarterly adjusted deleted EPS of $1.57, despite the continued challenges of the global pandemic. Most impressive was the continued strong growth of ICOs, which made up 13% of our volumes and nearly 30% of our adjusted net revenues compared to 24% in the prior year quarter. HTU shipment volumes grew plus 30% and plus 12% compared to the same quarter last year and the previous quarter, sequentially to reach 24.4 billion units with strong growth across key geographies. We also continued converting adult smokers at a good pace, surpassing an estimated 20 million users, of which almost 15 million have switched to ICOS and stopped smoking. Combustible net revenues grew by plus 4% in Q2 on an organic basis, reflecting a partial volume rebound against a week prior year quarter and solid pricing, partly offset by market mix. Our adjusted operating income margin expanded significantly in both the second quarter and first half overall. And while we expect commercial investment to step up in the second half, this puts us firmly on track for a strong 2021 performance organically with an expected currency tailwind providing additional growth in dollar terms. Importantly, this outlook also allowed us last month to confirm our share buyback program, where we target $5 to $7 billion over three years. We are also delighted to announce that IQOS Illuma, the next generation of IQOS, will be launched in Japan next month. As we covered at Invest Today in February, this represents a major step in category innovation as we seek to accelerate our journey toward a smoke-free future. With regard to long-term growth, we also took important steps to build our modern oral and beyond nicotine business in recent weeks through the proposed acquisition of Fertin Pharma and Victura, which I'll come back to later. Turning to the headline numbers, our Q2 adjusted net revenue grew by plus 11.6% on an organic basis, or around plus 18% in dollar terms. This reflects both the recovery of the combustible business in many markets compared to the heavily disrupted second quarter of 2020, including the need for higher inventory levels and the continued strength of ICOs with plus 35% organic growth in RRP net revenue. For combustible, while certain geography and channel remain significantly affected by the pandemic, notably in South and Southeast Asia, South America and global duty-free, reopenings in much of the world have led to partial recovery in social location and a sequential recovery in our market share. We witnessed good organic growth of plus 5.1% in our net revenue per unit, driven by the increasing weight of ICOs in our sales mix and pricing on both combustible and ROPs. Our adjusted operating income margin increased by 270 basis points on an organic basis. This reflects the increasing weight and profitability of ICOs, higher combustible volume, the positive impact of pricing, productivity savings, including lower device cost and lower commercial spend due to the pandemic. Our resulting adjusted deleted EPS of $1.57 represent plus 17.8% organic growth and plus 21.7% in dollar terms, a very strong performance. Looking at the first half overall, our adjusted net revenue grew by almost plus 12% in dollar terms and by plus 7.1% organically. This was achieved despite a tougher Q1 comparison and reflect the Q2 factors I just mentioned and the consistent growth of ICOs where progress through the pandemic has been impressive. notably including the doubling of users in the EU region since the end of 2019. We delivered strong organic growth of nearly plus 6% in our net revenue per unit, again reflecting our shifting business mix and pricing. Our H1 adjusted operating income margin increased by 440 basis points on an organic basis, While we plan to increase commercial investments in the second half, as we noted at Q1, this remains an excellent performance. Our H1 adjusted diluted EPS grew plus 19.6% organically and plus 25.6% in dollar terms, also a very strong result. This brings me to guidance for 2021. We now expect an even stronger organic performance for the year than previously, supported by improved total industry volume for combustible following the easing of pandemic restriction. For net revenue, we are revising our organic growth forecast to between plus six and plus seven percent, representing the upper end of the previous range. We continue to expect organic adjusted OI margin expansion of around plus 200 basis points and we are raising our organic adjusted diluted EPS growth range to plus 12 to plus 14% or plus 15 to plus 17% in dollar terms. We also continue to expect HTU shipment volume of between 95 and 100 billion units. Given the strong momentum across our market, the need to maintain inventory duration and preparation for the rollout of ICO Siluma, which uses different consumables, we expect our full year HTU shipment to be slightly ahead of IMS volumes. This projected organic EPS growth, including an estimated favorable currency impact of approximately 18 cents at prevailing rates, translate into an increased adjusted diluted EPS range of $5.97 to $6.07. This guidance does not include any material impact of share repurchase or acquisition. We recently received board authorization for the launch of our three-year share repurchase program, where we target $5 to $7 billion starting in the period following our Q2 earning release. Please note this program is not affected by the proposed acquisition of Fertin Pharma or Vectura. Turning now to some of the key H2 assumptions underpinning the guidance. We assume that many of our key markets will have largely emerged from COVID restrictions, supporting better industry volume. Where significant pandemic-related challenges remain, notably Indonesia, the Philippines, and certain markets in South America, we assume no significant further deterioration from the present situation. We continue to assume no meaningful recovery in duty free this year, with intercontinental and Asian travel still subdued. A rebound in travel within custom areas such as the European Union has limited effect. In addition, following combustible pricing of around plus 3% in the first half, we anticipate a somewhat softer second half progression. We continue to expect the full year variance to be plus 2 to plus 3%. This reflects continued pandemic related changes in certain markets, notably in South and Southeast Asia. H2 also faces tough pricing comparison from the 2020 VAT reduction in Germany and new excise tax terms in Australia. The global semiconductor shortage continues to put constraints on device supply. And while the overall impact remains manageable, we have adjusted our device assortment to limit the effect on consumer availability. This dynamic is included in our guidance and we continue to monitor the situation closely. Despite these factors, we have multiple growth drivers in our business, and we are confident in our ability to deliver continued robust top-line progress. This revenue assumption includes higher expected device shipment and the launch of high-cost Illuma, which will contribute to less gross margin expansion compared to the first half. As mentioned previously, we will also step up our commercial investment in key areas, including portfolio expansion and product launches, such as Icosiluma and Icosvive, smoke-free category understanding and awareness campaign, and a number of commercial development projects. We anticipate around $300 to $400 million of incremental spending compared to the first half, which will impact our H2OI margin, but overall still expect to deliver a very robust expansion of around plus 200 basis points for the year. For Q3 specifically, we expect EPS of $1.50 to $1.55. Lastly, we continue to expect around $11 billion in 2021 operating cash flow, at prevailing exchange rates and subject to year-end working capital requirements. Before discussing our results in more depth, I want to highlight some of the positive regulatory developments in the quarter. Recognition of the arm reduction potential of smoke-free products continues to gain traction. Examples in recent weeks include the passing of a broad differentiated regulatory framework for RP by the Philippines House of Representatives and the institution of differentiated excise treatment for heated tobacco products in Pakistan. In Mexico, the ban on the import and export of electronic nicotine delivery systems no longer applies to heated tobacco devices which will allow us to resume imports of high-cost devices. While we are encouraged that the German government has recognized the important principle of differentiation between combustible cigarettes and smoke-free products on the basis of potential health impacts, we view the announced excise tax changes on heated tobacco as misguided, providing less incentive for consumers to switch away from cigarettes to less harmful alternatives. We also note the differing views among the key political groups in the country ahead of the fall election, and we are hopeful a new government could revisit the decision. In the EU, more generally, we remain optimistic that the revision of the tobacco excise directive will lead to greater harmonization in the structural approach to non-combustible product, taking into account the relevant good practices and experience gained by member states. Turning back now to our quarterly results, Q2 total shipment volume increased by plus 6.1% and by plus 1.1% for H1. This reflects continued strong growth from HTUs of plus 30% to reach 24.4 billion units in Q2, driven by the EU region, Japan, Russia, Ukraine, and encouraging progress from recently launched market in the Middle East. HTU shipments were around 1.4 billion units ahead of IMS volume for the second quarter, reflecting the need to maintain inventory duration in the growing business, sea freight lead times, and the first shipment of Illuma consumable. The plus 3.2% growth in our Q2 cigarette volume reflect the recovery of a number of key markets compared to a notably weak prior year quarter when pandemic-related disruption was at its peak. While our cigarette share improves sequentially, we continue to face some specific market share headwinds in addition to market mix effects, which I'll come back to. Due to the impressive performance of ICOS, heated tobacco units comprise 13.3% of our total shipment volume in H1, as compared to 11% in the year of 2020, 8% in 2019, and 5% in 2018. We expect this proportion to grow over time as the positive momentum on ICOS continues, providing a powerful driver of revenue and margin growth. Our sales mix is changing rapidly, putting us on track to achieve our aim of becoming a majority smoke-free company by 2025. Smoke-free product made up nearly 30% of our adjusted net revenue in the quarter and in H1, compared to 23% in H1 2020. IQOS devices accounted for approximately 5% of the $4.4 billion of R&P net revenues, reflecting longer replacement time and fewer second device purchases for existing users due to improving battery lives, functionality and reliability, and lower device prices in certain markets as we prepare for ICO Siluma. The plus 7.1% organic growth in H1 net revenue on shipment volume growth of plus 1.1% reflect the twin engines driving our top line. First is pricing on combustible and in certain market on HTU net of the lower device pricing I just mentioned. Second, the increasing mix of HTUs in our business at higher net revenue per unit continues to deliver substantial growth. And as explained at Invest Today, this is an increasingly powerful driver as our transformation accelerates. Let me now go into the driver of our first half margin expansion. starting with gross margin, which expanded by plus 340 basis points on an organic basis. This is driven by multiple levers, as explained in prior quarters, including the mixed effect on HTU and pricing across our portfolio. Our significant effort on manufacturing and supply chain efficiency are bearing fruit, more than offsetting the effect of combustible volume declines. with around $300 million of gross productivity savings delivered in H1. This represents a strong start on the journey towards our target of $1 billion over 2021-2023. This was accompanied by strong SG&E efficiency with our adjusted H1 marketing administration and research cost 90 basis points lower as a percentage of adjusted net revenue on an organic basis. This reflects the ongoing digitalization and simplification of our business processes, including our high-cost commercial engine and more efficient ways of working. We delivered around $120 million towards our 2021-2023 target of $1 billion in gross SG&A savings before inflation and reinvestment. Focusing now on combustible, we hold the leading international portfolio by market share and by brand strength. This gives us a formidable platform to accelerate the growth of ICOs via our commercial infrastructure, industry expertise and ability to communicate with adult smokers where permitted. It is therefore important to maintain our leadership through selective investment as we also drive return through pricing and efficiency. Despite good results in markets like Mexico, Saudi Arabia and Turkey, our Q2 cigarette share remained below the prior year with over half of this share loss due to market mix reflecting our high exposure to market like the Philippines and low presence in certain emerging markets with a strong rebound such as Bangladesh. Importantly, our share improved sequentially compared to the first quarter and we expect this positive trajectory to continue through the second half. This reflects a partial recovery from the COVID impact on social occasion where Marlboro over indexes, border closures and travel. However, the expected recovery is also supported by portfolio initiative, including in the value segment and the enduring strengths of Marlboro. We continue to target stabilization in our cigarette category share over time with HTU gains coming on top. I will now turn briefly to the South and Southeast Asia region. As covered last quarter after a difficult 2020, notably in Indonesia, volume headwinds have been moderating. However, the pandemic remains a major issue in the region with renewed lockdowns in a number of areas. Daily consumption patterns are still below pre-pandemic levels and the pricing environment remains challenging. We continue to expect volume growth in Indonesia this year as the industry improves, with encouraging recent share gain within the Tier 1 segment where we participate. Our overall share in both Indonesia and the Philippines was sequentially broadly stable in Q2, with our portfolio initiative geared at further share recovery over the balance of the year. In RRPs, ICOs continue to grow strongly in Metro Manila with an exit share of over 1% for EATS. For the region overall, we remain on track to deliver positive organic net revenue growth over the April to December period as outlined on our Q1 call. Moving now to ICOS performance, we estimate there were 20.1 million ICOS users as of June 30. After the exceptional addition of around plus 1.5 million adult users in the first quarter, we added a further plus 1 million in Q2 and plus 2.5 million year-to-date, building on the step-up seen in the second half of 2020. Our accelerated pivot to digital and remote engagement during the pandemic, combined with strong momentum for the IQOS brand, is paying off. We further estimate that 73% of this total, or 14.7 million adult smokers, have switched to IQOS and stopped smoking, with the balance in various stages of conversion. Strong conversion rates notably reflect the increased prevalence of IQOS 3 Duo, which offers a superior user experience to previous device version. We seek to achieve even higher conversion rate over time with the introduction of innovation such as IQOS Illuma. This user growth again reflects widespread momentum across all key IQOS geographies, including the EU region, Japan and Russia. It also reflects the enrichment of our offer and the segmentation of the category with new products and more price points, both above and below our initial HTU offering. In the EU region, second quarter shares for each reach 5.5% of total cigarette and HTU industry volume, plus 1.6 points higher than Q2 last year. As mentioned last quarter, we expected sequential share for HTU to be broadly in line with the first quarter due to the effect of seasonality and pandemic-related fluctuation on the combustible market. Underlying trends remain strong, with Q2 HTU IMS volume growing plus 50% year over year and around plus 11% sequentially when adjusted for estimated trade inventory movements. We expect to see similar dynamic in the third quarter with broadly stable headline share versus robust underlying growth. This excellent performance includes strong growth across the region with Italy and Poland as notable contributors. We continue to grow our EU region ICOs user base doubling since the start of 2020 despite the pandemic to reach over 6.3 million. Strong performance continued in Russia with 8% sequential user growth in Q2 and our HTU share up by 1.3 points to reach 7.3%. As in the EU, sequential share can be distorted by the combustible market. Adjusted for estimated trade inventory movement, this reflects close to plus 30% year-over-year IMS growth. After the excellent progress and geographic expansion of ICOs in recent years, the heated tobacco category in Russia is now large and growing. This very positive dynamic naturally attracts competition and as seen before in markets like Japan, heavily discounted competitive offering can generate initial consumer trials. We continue to grow our user base and with both our existing price tier portfolio and the future launch of ICO's Illuma, we see ample room for further strong growth. While we have historically focused on Russia in our earning calls, there is broad HTU growth across the Eastern Europe region with Ukraine, Kazakhstan, and Southeast Europe significantly contributing. We show here the excellent overall regional growth trend in adjusted IMAs. Note that following recent international sanctions, ICOS is no longer available for sale in Belarus, where we achieved a Q2 offtake share in Minsk of almost 7%. We continue to see sequential volume growth for both our ETH and fit lineup in Russia and Ukraine. Moreover, the solid and fit consumable continue to supplement user acquisition. In both Russia and Ukraine, the majority of consumer purchasing a LIL device are smokers entering the smoke-free category for the first time with high level of conversion in line with ICOS, benefiting from our ICOS conversion infrastructure. With this success, We also introduced Lille Solide in five further markets in Eastern Europe this quarter, with additional markets planned later this year. Japan, the adjusted total tobacco share for our HTU brands increased by plus 2.3 points versus the prior year quarter, and by 0.2 points sequentially to 21%. highlighting the strength of our price tier portfolio and broad range of SQ following the October 2020 price increase. IMS volume, adjusted for estimated trade inventory movement, grew by around plus 5% sequentially after accounting for fewer selling days in the first quarter. We continue to expect robust underlying progress in user growth and consumer of tech, supported by the launch of ICOS Illuma in August. As in prior years, with an additional excise increase in October 2021, there may be volatility on the timing of IMS and consumer of tech between the third and fourth quarters. In H1, the overall heated tobacco category made up around 29% of the adjusted total Japanese tobacco market, with ICOS maintaining a high share of segments and capturing the large majority of the category's growth. In addition to strong growth in existing markets, the geographic expansion of our smoke-free product continues. This allows us to provide access to better alternatives to an ever-increasing amount of adult smokers, as we aim to be in 100 markets by 2025. Our second quarter launches in Kyrgyzstan and Uzbekistan with both ICOs and LIL offerings take the total number of markets where PMI smoke-free products are available for sale to 67, of which over half are outside the OECD. A core driver of our continued success in smoke-free products is innovation. We are very excited to launch IQOS ILUMA, the next generation of IQOS, next month in Japan. Bailing on the success of IQOS 3 Duo, we believe this simple and intuitive device will support easier switching and higher conversion for legal edge smokers using smart core internal induction heating technology. As outlined at Invest Today, ILUMA will come in multiple device formats, and have its own range of HTU consumables. The ongoing success of Icos 3 Duo, almost two years after launch, demonstrated that significant innovation can have a lasting positive impact on growth. We plan for further market launches of Icos Illuma through the remainder of this year and in 2022. Naturally, for a major new innovation, and as seen with earlier version of Icos, The unit cost profile of ICO Siluma devices and consumables begin at a higher level, but we expect this to improve over time as scale increases. This dynamic is included in our guidance assumptions. We are continuing to commercialize ICOs VIVE with good progress in the first group of markets where we started in our own channel with an initially limited range of test variants and nicotine levels. IQOS-VIV is a premium product providing a superior experience and as we explained previously, the commercial infrastructure of IQOS allows us to deploy efficiently and at scale through a bespoke route to market approach. As we start to expand distribution and the consumable offering, we see signs of increased uptake and clear positive consumer feedback relative to competitive products. We plan to launch in further markets later this year and will continue to test edge verification technology in select markets. In addition to e-tobacco and e-vapor, we announced in February our intention to enter the small but fast-growing nicotine pouch category this year. To complement our internal development, we have two important acquisitions to establish a base of capability in science, technology, and manufacturing, and build our platform in a modern role. The first of these was Aegis News, completed during the second quarter. Aegis News has a relatively small branded portfolio of modern oral products, which provide us a foothold in the category. In addition, the proposed acquisition of Fertin Pharma will give us access to a range of promising oral delivery technology and capability, some of which could be applied to the modern oral nicotine space. We will return with further news on our commercial plans in this area later this year. I also want to come back to our Beyond Nicotine strategy, which we first outlined at Investor Day. We see significant opportunities in adjacent areas with our two focus corridors of self-care wellness, including botanical, and in-health therapeutic expected to have an addressable market of around $65 billion by 2025. The proposed acquisition of Fertin Pharma and Vectura can enable us to more rapidly expand our development capabilities in innovative in-health and oral product formulation while continuing to grow their respective CDMO activities. 13 has a range of promising oral delivery technology, including pouches, gums, and lozenges, which can be applied in both the modern oral nicotine and beyond nicotine areas, notably for safe care wellness products. With Vectura, we would gain access to differentiated proprietary technology and pharmaceutical development expertise to deliver a broad range of complex in-air therapies. Vectura has highly complementary human capital, technology, high-quality infrastructure, and deep know-how of inalienable formulation and device design development and analysis, drug-device combination, and pharmaceutical management processes and systems. These proposed acquisitions would fully leverage PMI's existing capability in life science, product innovation and clinical expertise related to inhalation. Such acquisitions can also enhance our progress on important sustainability priorities. Firstly, building our capabilities in modern role is a key enabler of broadening the reach and access of our smoke-free alternative to adult smokers around the world. And secondly, building a strong beyond nicotine business is a major objective as we strive to develop commercially successful products with a net positive impact on society. On ESG and sustainability more broadly, we are firm believers in the power of investor engagement to drive positive change. Given PMI's unique sustainability and transformation story, we have increased our own outreach. We published our second integrated report in May, which provides a comprehensive, detailed, and transparent disclosure of how we create sustainable value and how we are progressing toward our purpose and target, including our most important commitment of all to phase out cigarettes. We also had a dedicated sustainability webcast on June the 2nd, where we covered the fundamental alignment of our transformation and financial performance with addressing our impact on society. We shared the latest studies using real-world data on the possible association between accelerated cigarette volume decline and certain disease reduction in Japan. We also reaffirmed our commitment to diversity, equity, and inclusion as an essential enabler of future success. We continue to make progress on our 2025 roadmap with notable development in Q2 being our second certified carbon neutral factory in Switzerland, taking us one step closer to achieving carbon neutrality by 2025 and the publication of our eco-design principle as we seek to play our part in the circular economy. In closing, after delivering 1% total volume growth and 7% organic revenue growth in H1, we have raised our 2021 organic growth expectation to plus 6% to plus 7% in net revenue and plus 12% to plus 14% in adjusted diluted EPS. We are on track for an excellent performance. Moreover, we continue to invest in the future. Most immediately, this means the launch of Aiko Siluma in Japan next month and in more markets later this year. We are also investing in the broadening of our smoke-free product portfolio and geographic reach. This is critical as we seek to accelerate the number of adult smokers who switch to better alternatives with a growing positive impact on society. In addition, we are investing in the capabilities of tomorrow, as illustrated by our two recent proposed acquisitions, which provide a comprehensive development platform across our Beyond Nicotine focus areas. Finally, we are also committed to returning cash to shareholders through dividend and share repurchase, in line with our objective to deliver sustainable value and return to investors as we continue our journey towards becoming a majority smoke-free business. Thank you very much. I am now more than happy to answer your questions.