Philip Morris International Inc

Good day and welcome to the Philip Morris International Third Quarter 2021 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 the number 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, and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2021 third 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 slide, which are 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. Following the acquisitions of Fertin Pharma, Otatopic, and Vectura Group, PMI added the other category in the third quarter of 2021. Business operations for the other category are evaluated separately from the geographical operating segments. 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. It's now my pleasure to introduce Emmanuel Balbeau, 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 another strong performance in the third quarter of 2021, coming ahead of our expectation to achieve a record high quarterly adjusted deleted EPS of $1.58. Most notable was the continued excellent growth of high-cost driving plus 33% Q3 organic growth in RRP net revenue and plus 7.6% for total PMI. HTU shipment volumes grew plus 24% compared to the same quarter last year to reach 23.5 billion units with growth-based growth for both our volume and the category across key geographies. This was delivered despite ongoing tightness in device supplies due to the global semiconductor shortage, which impacts high cost user growth rates. In combustibles, further sequential share gains supported total PMI volume growth of 2.1% in Q3, and we continue to expect total cigarette and HTU volume growth for the year. We are firmly on track for a strong 2021 organic growth performance, with an expected currency tailwind providing additional growth in dollar terms. We are also delighted to share outstanding initial results from Icosiluma in Japan and growing traction for Icosviv in early launch markets. In the quarter, we made three milestone acquisitions as we build our business for the long term to include products that go beyond tobacco and nicotine. Our smoke-free transformation is now also reflected in our financing with the launch of an industry-first business transformation-linked financing framework, and we continue to prioritize return to shareholder through a 4.2% increase in the dividend and ongoing share repurchases. Turning to the headline numbers, our Q3 net revenue grew by plus 7.6% on an organic basis or plus 9.1% in dollar terms. This reflects the continued strength of ICOS and the recovery of the combustible business in many markets. We witnessed good organic growth of plus 5.4% in our net revenue per unit, driven by the increasing weight of ICOS in our seismics and pricing on both HTUs and combustibles. Our adjusted operating income margin decreased by 10 basis points on an organic basis. This reflects the expected initial higher unit cost of ICOS Illuma and increased commercial spend partly related to its launch offsetting the continued positive effect from the increasing weight and profitability of ICOS, pricing, and productivity saving. Our resulting adjusted deleted EPS of $1.58 represent plus 8.5 organic growth and plus 11.3 in dollar terms, a very good performance. Looking now at year-to-date performance, our adjusted net revenues grew by almost plus 11% in dollar terms and by plus 7.3% organically. This reflects the consistent growth of ICOS, where progress throughout the pandemic has been impressive. We delivered strong organic growth of nearly plus 6% in our net revenue per unit, again reflecting our shifting business mix and pricing, with pricing on combustible at just over 3% or around 5% excluding Indonesia. Our year-to-date adjusted operating income margin increased by 280 basis points on an organic basis, an excellent performance driven by our top-line growth engine of ICOS and pricing combined with operating leverage and productivity savings. Our adjusted diluted EPS grew plus 15.8% organically and plus 20.4% in dollar term, also obviously a very strong result. This brings me to guidance for 2021. We are revising our organic growth outlook for net revenues to plus 6.5% to plus 7%. representing the upper half of the previous range and reaffirming the strong outlook for organic or high margin expansion of around 200 basis points. We also confirm our currency neutral adjusted deleted EPS growth forecast at the upper end of our previous range, reflecting plus 13 to plus 14% growth or plus 16 to plus 17% in dollar terms. This translates into an adjusted diluted EPS range of $6.01 to $6.06, including an estimated favorable currency impact of 17 cents at prevailing rates. Following on from our most recent public comment, as the tightness in device supplies persists, we now expect our HTU shipment volume to be around 95 billion units, as we prioritize devices for user retention. Given the continued growth of HTUs and the need to maintain inventory duration, we continue to expect our full year shipments to be slightly ahead of IMS volumes. This guidance does not include any material impact of share repurchases or acquisition. Share repurchases through October the 15th amount to around $117 million after some limitation during Q3 from blackout restriction. In terms of other assumptions, we are assuming only a limited Q4 recovery in duty-free, following a modest improvement in Q3 with intercontinental and Asian travel still very subdued. We continue to assume fully a combustible pricing of plus two to plus 3%, with a softer expected Q4 reflecting continued pandemic-related challenges in certain markets, notably in South and Southeast Asia, as well as tough comparison in Germany and Australia. Lastly, in 2021, we continue to expect around $11 billion of operating cash flow at prevailing exchange rate, subject to year-end working capital requirements. We also update our expectation for full year capital expenditures to around $0.6 billion, reflecting latest launch plans and pandemic-related timing factors. Before discussing depth, I am pleased to report some recent positive regulatory development further to those shared in previous quarters. For example, Switzerland adopted a new federal law on tobacco products and e-cigarettes, defining dedicated product category and differentiated health warnings. In New Zealand, the government has now published new regulations for smoke-free products, which allow branded packaging to be reintroduced with a specific text health warning. In Egypt, earlier this year, smoke-free products were clearly differentiated from combustible cigarettes in both physical and regulatory treatment. There is a growing body of scientific and real-world evidence of the substantial risk reduction potential of non-combustible alternatives compared with smoking. While fluctuations across different markets are to be expected, we continue to support regulatory and fiscal frameworks that recognize this critical harm reduction opportunity. Turning back now to results, Q3 total shipment volume increased by plus 2.1% and by plus 1.5% year-to-date. This reflects continued strong growth from HTUs of plus 24%, driven by the EU region, Japan, Russia, Ukraine, and encouraging progress from recently launched markets in the Middle East. HTU shipments were around 1 billion units below IMS volume for the third quarter, primarily reflecting timing around the August Illuma launch and the October tax-driven price increase in Japan. We expect this dynamic to reverse in Q4. The minus 0.4 percent decline in our Q3 cigarette volumes reflect the continued sequential recovery of total industry volume and of our market share. Due to the impressive performance of ICOS, the tobacco unit comprised 13 percent of our total shipment volume here today, as compared to 11% in full year 2020, 8% in 2019, and 5% in 2018. 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 products made up almost 30% of our adjusted net revenue year to date, compared to 23% for the same period in 2020. IQOS devices accounted for over 6% of the $6.7 billion of RP net revenue, with a step-up in Q3 reflecting the IQOS Enuma launch, which outweighed the effect of supply constraint on other IQOS versions. The plus 7.3% organic growth in year-to-date net revenues on shipment volume growth of plus 1.5% reflect the twin engines driving our top line. The first is pricing on combustible and, in certain markets, on HTUs. Second is the increasing mix of HTUs in our business at higher net revenue per unit which continues to deliver substantial growth and increasingly powerful driver as our transformation accelerates. Let me now go into the driver of our year-to-date margin expansion, starting with growth margin, which expanded by 240 basis points on an organic basis. While expansion was lower in Q3 as Illuma devices were shipped to Japan for the launch, the multiple positive levers discussed in prior quarters continue. Our significant effort on manufacturing and supply chain efficiencies are also bearing fruit with around $450 million of gross productivity savings delivered. was accompanied by robust SG&A efficiencies with our adjusted year-to-date marketing, administration, and research costs 40 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 partly offset by increased commercial investment in Q3. With SG&A saving of more than $200 million before inflation and reinvestment, this means we have generated over $615 million in overall growth efficiencies year-to-date. This is strong progress toward the combined target of $2 billion for 2021-2023. Moving to market share, sequential gains for both our high-cost and combustible portfolios give us strong momentum going into Q4 and next year, despite an approximate 0.3 point year-over-year drag in Q3 from market mix. Importantly, we expect further improvement in the fourth quarter for HTUs with record shares across key high-cost geographies. For combustible, the improving total market volume backdrop includes notable recovery in Indonesia, Turkey, and Mexico, and close to stable Q3 industry volume in the EU region. Our share of the combustible category has strongly recovered on a sequential basis, moving us one step closer to our target of stable share. as our portfolio initiatives bear fruit and pandemic-linked restrictions recede in many markets. In South and Southeast Asia, renewed COVID-linked measures have somewhat dampened the recovery, though industry volumes have nonetheless improved sequentially in Indonesia and in the Philippines, where the year-over-year trend is impacted by a challenging prior year comparison. Our share in the region grew sequentially, albeit less than expected, primarily given pandemic-related developments in the Philippines. Let's now turn to the tightness in device supply due to the global semiconductor shortage. As we communicated in September, With demand continuing to grow, this has already affected the availability and assortment of high-cost devices in certain markets in Q3, which impact our ability to run at full commercial and competitive capacity and fulfill consumer demand. Device shipments outside Japan were limited to a 7% year-over-year increase, significantly below the growth in HTUs. This resulted in slower user growth of several hundred thousand in the quarter, notably in Russia, given limitation on the IQOS 2.4 plus device as flagged in recent communication. At this stage, semiconductor supply forecasting remains volatile, so we assume the tight supply situation will persist into the first half of 2022. we will continue to carefully prioritize necessary device replacement for existing users, followed by device sales targeted at acquisition. The successful start of ICO Siluma in Japan confirms it will be a significant driver of acquisition and retention. Nonetheless, at the beginning, it triggers significant upgrade from the existing large ICOS user base, many of whom don't really need to replace their devices. This is a highly desired consumer behavior in normal supply circumstances, but increases constraint in a shortage. Therefore, we now assume that additional major launches will only take place in the second half of next year. Given this evolving situation, we have continued important commercial investment in key area. This includes portfolio expansion and product launches, such as ICO Sinuma in Japan and ICO's VIVE, smoke-free category understanding and awareness campaign, and a number of commercial development projects. Including the investment already made in Q3, we anticipate around $300 million of incremental H2 spending compared to the first half. Overall, this is a temporary phenomenon, and with demand remaining strong, we expect user growth to re-accelerate once shortages ease. We have a pipeline of exciting innovations on devices and consumables, including but not exclusive to Illumar, and a number of new market entries planned. There are short-term shortage scenarios under which the transitory supply impact on user growth could result in 2022 organic growth below our 2021-2023 targeted average rate for net revenues or high margin expansion and adjusted deleted EPS. Nonetheless, with a strong 2021 as a base and a robust re-acceleration post-shortage, we confirm our confidence in our 2021-2023 growth targets. Moving now to ICOS performance, we estimate there were 20.4 million ICOS users as of September 31st. Excluding the impact of international sanctions in Belarus, this reflects growth of around 0.4 million users in the quarter, with a rate of growth subdued by the tightness of device supply and the time needed to adjust our commercial programs. As demonstrated again by the Illuma launch in Japan, the underlying momentum of the high-cost brands remains strong. Following adjustments of our program and assortment, we expect Q4 user growth to improve by a few hundred thousand compared to the growth seen in Q3. The reduced user growth for the second half should therefore be broadly consistent with the potential 2 to 3 billion HTU impact flagged in recent communications. We estimate that 73% of total users, or 14.9 million adult smokers, have switched to ICOS and stopped smoking with the balance in various stages of conversion. The user growth again reflects acquisition across key ICOS geographies despite device constraints. In the EU region, third-quarter share for EATS reached 5.3% of total cigarette and HTU industry volume, plus 1.4 points higher than Q3 last year. As mentioned last quarter, we expected sequential share for HTUs to be broadly stable due to the effect of seasonality and pandemic-related fluctuation on the combustible market. Underlying IMS growth trends remain excellent, and as in the prior year, we expect a strong Q4 in both volume and market share terms. This very good performance includes strong growth across the region with Italy, Germany, and Poland as notable contributors. Robust performance continued in Russia with our Q3 HTU share up by plus 1.1 point to reach 6.9%. While lower than Q2, notably due to the seasonality of the combustible market, we expect further sequential growth in IMS to deliver a strong quarterly share increase in Q4 as in the prior year. We had the largest limitation on lower-priced devices and related commercial programs in Russia, and we have seen some increased consumer trials of discounted competitor offerings and disposable e-vapor products. However, we continue to see high interest in the category, and with both our existing price tier portfolio and future innovations supporting our clear category leadership, we see ample room for further strong growth over time. There is also broad HTU growth across the Eastern Europe region, with Ukraine, Kazakhstan, and Southeast Europe contributing. This slide shows the positive overall regional growth trend in adjusted IMS, albeit somewhat dampened on a sequential basis by the halting of shipments to Belarus due to international sanctions and timing factors in Kazakhstan. In Japan, the adjusted total tobacco share for our HTU brands increased by plus two points versus the prior year quarter due to 20.8%, and adjusted IMS grew sequentially to reach a record high of 8.2 billion units, reflecting the strength of our portfolio and the launch of Icosiluma. Adjusted sequential share fell by 0.2 points sequentially, reflecting volatility in the total market ahead of the October 1st excise increase in addition to normal seasonality. While consumer pantry loading effects may wait on Q4 IMS, we expect further robust underlying growth in volume and a nice sequential improvement in market share. The overall heated tobacco category continues to grow, making up almost 30% of the adjusted total Japanese tobacco market in Q3, with ICOS maintaining a high share of segment and capturing the majority of the category's growth. In addition to strong growth in existing market, We continue to drive the geographic extension of our smoke-free product as we aim to be in one of the markets by 2025. During the quarter, we launched IQOS in Egypt, the first in Africa, and reached an off-tech exit share of 2% in urban Cairo. We are also now at Norway and Iceland, where our recent acquisition of AG Snooze gives us a presence in the snooze and nicotine pouch category. This takes the total number of markets where PMI smoke-free products are available for sale to 70, of which 28 are in low- and middle-income markets, which we are introducing as a more robust measure of making smoke-free products available to adult smokers in emerging countries. Again, we may have some delays in this market expansion program in the first half of 2022. Given our smoke-free leadership and global reach, let me pause and share a few words regarding the strength of our intellectual property. Across all our smoke-free products, we have strong patents and have been the clear leading innovator in the tobacco category over recent years, investing billions of dollars in the process. Despite attempts to disrupt our business through litigation by a competitor who lags behind on R&D and innovation, we have been universally successful in defending our product against IP challenges in all 11 ruling outside of the US, including the UK High Court and at the European Patent Office. The US ITC is a federal agency which, among other things, deals with imports trying to ensure a domestic industry or violate U.S. intellectual property rights. We also note the two patterns mentioned in the ITC final determination were both drafted after ICOS had been launched. The FDA fulfilling the exclusive public interest mandate given to it by Congress for tobacco product has already found that ICOS is appropriate for the promotion of public health and expected to benefit the health of the population as a whole. We are hopeful in the current presidential review period that the U.S. Trade Representative will consider the impact on current American ICOS users and the many more that would be denied access. In the scenario where the ITC determination is upheld, While the financial impact of this scenario is immaterial given the early stage of the U.S. high-cost rollout, this would unfortunately mean that U.S. consumers would be unable to buy high-cost for a period of time. Meanwhile, our contingency plans are underway and include domestic manufacturing. The U.S. Patent Office is also reviewing certain claims of the patents in question with initial ruling expected in 2022. abide subject to an appeal process. While the ITC ruling may cause near-term disruption to the U.S. availability of ICOs, we continue to see a large opportunity for ICOs in the United States over the coming years. The global ICOs innovation story took a historic step forward in August with the launch of two Illuma devices and a range of Terea HTUs in Japan. Building on the success of iCODE3 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. With the national rollout taking place at the start of September, initial results were outstanding. with device sales well ahead of all comparable past launches at the same stage, despite some limitation on device availability, and the proportion of new users growing to 18%. Terrier purchases are growing rapidly, exiting the quarter at over 10% of total PMI HTU of tech volume. Consumer feedback has also been very positive with mid-teens increases in the net promoter score. Following this success, we plan to launch in our second market of Switzerland next month and look forward to additional major launches in 2022 when circumstances allow. We continue to commercialize iCodeV with good progress in the first group of markets where we started in our own channels with a limited range of test variants and nicotine levels. IQOS-V is a premium product providing a superior experience, and 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 related to competitive product. We see encouraging early success in Italy where Vive reached an estimated 7% national exit volume of tech share of closed system product, system pod, sorry, despite not yet being available nationally. And in the Czech Republic with an estimated 8% national volume of tech exit share. We also launched in Croatia in Q3, Canada in October, and plan to launch in Ukraine before year-end. We also continue preparations to apply for a PMTA from the US FDA in the second half of 2022. Turning now to our strategy to move into new business areas beyond tobacco and nicotine, which focuses on leveraging and complementing our existing capabilities in the healthcare and wellness space. We see significant opportunity in adjacent area with our two focus corridors of self-care wellness, including botanicals and in-health therapeutics expected to have an addressable market of around $65 billion by 2025. The acquisitions of 13 Pharma, Orcitopic, and Vectura enable us to more rapidly expand our development capabilities with over 250 scientists, infrastructure, technology, and expertise in innovative in-health and overall product formulation while continuing to grow CDMO activities. As shown on this slide, this opens up a number of highly complementary opportunities and new focus areas. This acquisition will fully leverage PMI's existing capability in life science, product innovation, and clinical expertise related to innovation. We look forward to updating you more in the future on our plans and progress in these exciting new areas. Moving to sustainability and our ESG priorities, we continue to make good progress toward our purpose through advancing our transformation and addressing our most material impact on society. We broaden access to our smoke-free product by increasing the availability to adult smokers around the world with new product launches across a growing range of market and smoke-free categories. In addition, our recent acquisition builds our human, intellectual, and social capital, adding smoke-free capabilities and laying the foundation for a strong business in areas beyond tobacco and nicotine as we strive to develop commercially successful products that seek to have a net positive impact on society. I am proud to highlight the recent publication of our business transformation linked financing framework and subsequent refinancing of our revolving credit facility. The framework, which follows ICMA principles and receives a second-party opinion from S&P, links our financing to material sustainability targets in our transformation. we remain on track to achieve carbon neutrality of our direct operation by 2025, five years ahead of our 2030 target. In addition, with the United Nations Climate Change Conference approaching, we plan to publish a robust low-carbon transition plan and a white paper on climate justice, which highlights the connectivity between environmental and social issues. Overall, we are on track for excellent top and bottom line growth performance in 2021 with a strong underlying momentum for high cost and robust cash generation. We are 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 three recently announced acquisitions, which provide a comprehensive development platform in self-care wellness and in health therapeutics, and strengthen our position in modern oral nicotine. We have increased cash returns to shareholders in Q3 through a higher dividend and our share repurchase program in line with our objective to deliver sustainable value and return to investors as we continue our journey towards becoming a majority smoke-free company. We have a pipeline of exciting innovation for both devices and consumables, and we expect high-cost user growth to re-accelerate when device shortages ease. We continue to see a strong future for our business and remain confident in our 2021-2023 organic growth target. Thank you very much, and I'm now happy to answer your questions.

Thank you. We will now conduct the question and answers portion of the conference. Again, in order to ask a question or make a comment, please press the star key followed by the one on your touchtone phone. In the interest of fairness and time, we ask that participants please keep a maximum of two questions each. If time allows, follow-up questions may be taken. You may rejoin the queue again by pressing the star, then the one, on your touchtone phone. And we will take our first question from Gaurav Gann with Barclays.

Hi. Good morning. Thank you for taking my questions. Hi, Manuel. So my first question is on the, you know, 2022, you know, sort of comments around growth rate being lower than, you know, the range you have given for 2021 to 23 because of, you know, issues around device supply. Now, if device supply is lower and your IQOS acquisition is lower, then doesn't it imply that your commercial investments are also lower and so it should be beneficial to your EPS? Or is that a correct way, incorrect way of thinking about things?

So, thank you, Gaurav, for the question. First of all, let me repeat that this is one scenario, the fact that the constraints are going to stay with us in H1 next year. This is not the only one. So you have more favorable scenario. And at that stage, frankly, it's a fast moving super fluid situation. So we don't know. But I think it was really important to share the possibility that the pressure on availability that we are seeing in H2 2021, we're still going to see it in H1 2022. So that's the scenario you are referring to and in this situation yeah we would see after this six months second half of 2021 we would see another six months period with reduced acquisition versus the underlying potential that we have seen in H1. In this situation, no doubt that, of course, the spending would be impacted by the fact that the number of launches or a number of commercial activities are not happening. That's very clear. But at the same time, as I think we've been very clearly saying it today, we are absolutely sure of the very strong potential of ICOS, and we think that this potential remain absolutely unchanged by what's going on so there will be when the shortage is a very nice acceleration on top of that we will be coming at the same time with very exciting innovation. You know Illuma, there is more in the pipe. So we're going to make sure even when there is some limitation on availability that we keep building awareness, we keep building the category, but also the ICOS franchise. So not all the cost will go away because we're going to, I mean, we are here to make a success as you know, on the long time and not managing only six months. So, yes, there would be in this scenario, once again, it's one scenario among others, there would be reduction in investment. But as you can see in 2.3, we continue to invest even when there is some limitation because we are building this long-term success that is extremely clear in the outlook that we have.

Thank you. And, you know, a follow-up question on, you know, sort of your U.S. strategy. And there are a number of almost like cross-currents going on that, you know, you're partnering with Altria for ICOS. And, you know, they are now, you know, you have lost the lawsuit versus BAT. And there is a potential that you have to do domestic production of your devices. Then you are also planning to file a PMTA for ICOS Weave later next year. So that could also be a Potential new product in the US market and then you have also acquired Fulton which also gives you capability to Potentially launch a model oral product in the US if you file for that PMTA as well So how should we think about you know in some parts you will be partnering with Altria in some other parts You could potentially be competing with Altria. So how does it all fit together? I

Thank you, Gaurav, for the question. Let me clarify it again. We have a commercial partnership with Altria on heat-not-burn tobacco products. That's very clear. We're going to see what is the final outcome of this ITC question. I will not rush to the final conclusion. You know, we are at the time of the presidential review. We frankly think it's going to be a defining moment for the objective of the FDA of tobacco harm reduction. I think the administration has a great opportunity here to flag how important this tobacco harm reduction policy is. And that would mean to protect ICOS, which is the only inel and nicotine product that is today benefiting from an MRTP in the U.S. So we are still hopeful that we're going to get a positive conclusion after the presidential review for us. In the case that it was not the final outcome, of course, we'll continue to work with Altria. The development will be a bit delayed. We'll find a solution to overcome the ITC decision, and we've been flagging the fact that it could go for local production. And as I think I've been saying during my notes, we remain absolutely convinced of the very strong potential of high-cost in the US. So that's one thing. And then you have the other RT category where indeed we have ambition. I mean, you've said it. We are going to file for a PMTA for VIVE. We could be considering launching modern overall product at a certain point in time as well. And on this one, all the options are open. So we don't have any commercial agreement today. And we will decide in due course how we want to launch and which kind of setup or partnership. But no decision has been made at that stage.

Thanks a lot, Emmanuel. Thank you, Gaurav.

We will take our next question from Bonnie Herzog with, I apologize, Goldman Sachs. Your line is now active.

Thank you. Hi, Manuel. I had a couple of questions on ICO's performance during the quarter. First, is there any sense of how much stronger device sales could have been in the quarter without the supply constraints? In other words, curious to hear from you how strong orders might be for new devices. especially on Illuma. And then maybe if you could share how big of a backlog there is. And then surrounding this, you know, issue, I just was curious to better understand what gives you the conviction that, you know, these issues are going to subside by the second half. And, you know, just thinking about the risk, you know, if these shortages last longer. And then finally on this topic, you know, are there any contingencies, you know, you guys might be working on or any way for you to be less dependent on the semiconductor suppliers going forward.

Thank you, Bonnie. First question on the potential in terms of cell of device during Q3 without the constraint. We are saying that we've been missing several hundred thousand of cell of devices, so it's obviously very material, and we've been reporting the fact that Outside Japan, and really we have to look outside Japan because Japan with the launch of Illuma was a specific situation. So outside Japan, devices have been growing by 7%, which is of course very, very significantly below the underlying growth of our market. And we are growing still close to 25% even in Q3. So that I think gives an idea of the kind of gap that we may have been facing during this quarter. We believe, as I said, that during Q4, as we now have a better, I would say, grip on things, we've been managing on the re-assortment, re-allotment, we have a better understanding of the kind of commercial actions that are giving the best possible return. We have a very clear view on how we're going to prioritize. So we believe that we are going, even still, severe restriction on devices. I'm not able to say whether that would be exactly the same level, but let's take that as an assumption, the same level as Q3. We believe that in terms of user growth, we could do better than in Q3, and we mentioned a few hundred thousand better user growth acquisition. So altogether, that means that If you believe that the underlying growth rate was between 4.5 to 5 million users a year that we have seen in H1, we're going to miss anywhere between 1 to 1.5 million user growth in H2 altogether. And that is absolutely consistent, so that was something that was already here in September, at the beginning of September, that is consistent with the 2 to 3 billion impact that we mentioned at the beginning of September. But I hope it helps you, you know, have some understanding, better understanding of the impact of the device shortage and how you should see it. on how we are working, I can tell you, around the clock to manage this shortage. We are using all possible levers. So of course we are in very intense discussion with our suppliers. exploring all possibility we are permanently you know optimizing the planning and of course it's quite complex because we talk about shortages on various type of IC but and they are not all entering into the same kind of reference of our range so we are managing that as well we are looking at the spot by market as well and and we've been buying a little bit and maybe we could be able to to have even more success there. So we are really putting all the lever we can to minimize the impact. And today what we are hearing is that the number of capacity should kick in in the first half of next year. I would tend to think there is a kind of consensus on the fact that H2 next year should be much better in terms of constraint, if not fully back to normal. So this is an assumption that we have today, but I have to admit that we've seen the situation moving fast, rapidly, and as I said, maybe things are going to improve because something is going to happen in the overall demand of the economy in the next six months. So maybe there could be even an improvement in H1. That's a scenario. Does it mean that another scenario that H2 could be with more question mark? Well, maybe. That's not what we are hearing when we talk with our partner and supplier so fast, but I have to admit that nothing is totally clear at that stage.

Okay, super helpful. If I may, I'd like to maybe squeeze in another quick question. Just during this period of slower ICOS device sales and new user acquisition, how should we think about your total volume growth? So is it safe to assume your combustible SIG volume will be elevated during this period of slower ICOS device sales and essentially be strong enough to more than offset this? And then given this dynamic, how should we think about this mixed impact on your margins in the next few quarters? Thanks.

Sorry, the line was not very good, but you were asking how we should expect the impact on user acquisition versus volumes, correct?

Sorry, if it didn't come through. More so on the mix, Emmanuel, because I'm thinking during this period of slower ICOS device sales, combustible SIG volume could be elevated. So think about that mix dynamic and impact on margins.

Look, we continue to target very nice growth of ICOs, and it is a brilliant category altogether, and of course, as the arch leader of this category, we see that continuing in the coming quarters. And as you know as well, that is coming with a very nice mix in terms of revenue per stick, and it's still very much visible. in our Q3 numbers, and we also flagged the fact that that was positive in terms of gross margin rate for the consumable business, the ICOS business. Maybe, you know, if the growth is a bit weaker because of this situation, the positive mix will continue to evolve favorably at a lower pace, but that's going to continue to be nicely positive. And on top of that, of course, then there is a question of, okay, what are we going to spend in terms of SG&A in this kind of situation? So it's difficult to say that it's going to be necessarily having a negative impact the margin and we are talking about very powerful driver on our financial performance and even once again if the growth rate is going to decrease a bit it's still going to be significantly higher than any evolution on CC and it's going to still continue to deliver a positive impact on on the mix all right thank you so much again thank you

And we will take our next question from Pamela Kaufman with Morgan Stanley. Your line is now open.

Hi, good morning. Good morning. I have a follow-up question about the outlook for next year and the scenarios that would drive the risk to be below your midterm target. It sounds like you're anticipating weaker 1H supply and an improvement in the second half. Would this scenario drive your results to fall below the 5% and 9% revenue and earnings growth target, or would supply conditions need to worsen relative to these assumptions?

Of course, we can play without limits with various scenarios. We have to admit that we've been seeing already in Q3 a weakening of user growth. As we said, even if we expect in Q4 an improvement versus Q3, it will still be below the underlying trend. And then in the scenario that we are describing, we say if the shortages continue in H1 next year, that's when we're gonna face this pressure on growth. So it's difficult for me to just comment on one scenario, but clearly that's the accumulation of what has been happening in H2 this year, 2021, and what could happen the beginning of next year, so H1 2022, that could drive a reduction in the potential growth rate Next year which would be temporary once again, and you know when there is a rebound the reaction will come But that that would be the combination that would trigger Something that could be below our average growth target Yeah, thank you that was helpful I

My next question is on the ITC decision. Can you elaborate on your contingency plans for making ICOS available in the U.S.? What would be the timing of manufacturing ICOS in the U.S.? And just to clarify, does the ruling also pertain to Illuma technology? In terms of bringing Illuma to the U.S. market, is there an opportunity to bridge ICOS's PMTA application for Illuma to accelerate its entry into the U.S.? ?

Regarding the ITC contingency plan, if eventually the presidential review was not favorable, but I want to repeat before answering you that we are hopeful that this presidential review will have a positive outcome for us for the reason I mentioned previously. I cannot elaborate further, unfortunately, but clearly it's part of what we described, the fact that we could have some local production as an element. But I won't elaborate further on how this could happen and how we would get there. On the ILUMA PMTA, Frankly, we would need to have a discussion with the FDA on the process and how the process would be carried by the FDA. And at this stage, I'm not able to answer you. So we would certainly require, ask for a PMTA on Illuma at a certain time, but I'm not in a position today to comment on timing.

Okay, understood. Thank you. Thank you, Pam. Thank you.

We will take our next question from Vivian Azar with Cowan. Your line is now open.

Hi, thank you. Good morning.

Good morning, Vivian.

I apologize for belaboring the ITC issue, but I've got a question on that too. You noted your track record of success in terms of defending against litigation internationally. Can two questions please? Number one, Are there current cases that are still pending internationally around IP litigation? If so, can you outline where those exist? And number two, can you just clarify that the litigation that you've successfully defended addresses the exact same claims that were reviewed by the ITC? Thank you.

So there are a number of cases pending. I won't elaborate on that. Not all of them are public and notably in Europe. And I just want to repeat that so far in Europe we've been on 11 cases, you know, trial or appeal, we've been successful. So I think it tells a lot about the strength of what we've been doing. Yes, some of the patents on which the ITC based their decision before presidential review are patents that have been reviewed by a number of courts in Europe. and that would be the UK court, and they are already of the same family. And the UK court precisely has invalidated the two family of patent that are at the origin of the ITC decision. And the European Patent Office already invalidated one of these family of patents. So even here fundamentally on the merit of the patent and the validity of the patent, We have been going through success in Europe.

That's helpful. Thank you. And then my follow-up question is on combustible cigarettes. The outlook is getting modestly better. Pricing, you've reiterated. If I recall correctly, as we kind of started the year, I think there was a point of caution around pricing with COVID uncertainty, et cetera, et cetera. What is your view of the consumer? I know it's a broad question. You operate in a lot of markets. But if you were a little bit conservative or cautious on pricing when we started the year, what is your feeling about your ability to take pricing today? Thank you.

Well, you can still give me the remaining weeks for the year before I can elaborate on next year. I think it's still quite unclear what's going to be the environment. One might think that inflation clearly accelerating in many countries will maybe build a global environment that could be better than what we thought initially, but that's still early time. So I'm not able to comment at that stage. So I will keep a cautious stance, which was built, you probably remember, on the aftermath of the COVID and the impact of many economies still being under shock. So we were seeing that that was probably not making a great landscape for price increase. But I have to admit that I don't know what's going to be the impact coming from what seems to be a general increase in inflation, and maybe that is going to create a more favorable situation. But bear with us still a couple of months before we can have a clearer view on that one.

Understood. Thank you very much.

Thank you.

And we will take our next question from Chris Groh with Stifel. Your line is now open.

Thank you. Good morning. I had a question. Hi, Emmanuel. Thank you. I just had a quick follow-up on the supply shortage. Sorry to keep going there, but I did hear some effect on the 2.4 device. I know it's limiting Illuma's launch in some markets. Is this chip shortage true for all your products, those 3.0 and Duo? Just to be sure, are those also affected by the chip shortage?

Well, Chris, that would, you know, mean that we would need to enter into great detail of how we are prioritizing our portfolio. And I don't think I want to do that because, of course, that's quite strategic for us. What is very clear is that we have one north star, if you want, which is to first protect our existing ICOS user and to make sure that we make devices available when they want to renew the device. And second, of course, we want to optimize any commercial action to make sure that we have the highest return on any new device that we are selling and that we avoid as much as possible selling device with a very low percentage of utilization afterward by the consumer. And certainly for us, moving and taking the benefit of that to step up the blade technology and move IQOS 3 as a priority instead of IQOS 2.4 plus was one of the moves that we have decided to make. And that explains why we have some more limitation. On top of the fact that due to component issue, there was also more pressure on 2.4. Obviously, in this kind of moment where a lot of things are on the table, you are managing constraint and long-term strategic vision as well. So that's what we are doing.

Thank you. Thank you for that color there. And I had just a separate question in relation to some of your beyond nicotine and tobacco acquisitions. At the topic in Vectura, in particular, respiratory drug companies, I just had a simple kind of high-level question. Do you need more pieces to fit that vision you have for respiratory drugs? And just understand kind of what stage we're at in terms of your acquisitions to understand if you need to do more here in the short term, if this is a good base to which you can build this element of your beyond nicotine sales.

So globally, we think that we have put on Beyond Nicotine a great platform, if you want, and notably in terms of R&D. And I think there is a lot we're going to be able to do already with this acquisition. Now, does it mean that in the future we could think of other Bolton acquisitions that would bring additional capacity that we don't have here maybe, but I think for the time being we're going to focus on making sure that we integrate these acquisitions and we maximize the synergy in terms of R&D, which were really two big objectives to combine strengths on R&D, and we optimize by putting know our skills, talent together, we optimize what we can do already in health therapeutics, but I could make the comment as well for 13 and self-care wellness.

And just to be clear, these acquisitions should not take you away from your separate goal of repurchasing your shares. That's kind of the main thing I was looking at, just to understand future capital commitments that could be required here.

No, absolutely, Chris. Nothing has changed on our buyback program, absolutely.

That's great. Thank you so much. Have a good day.

Thank you.

And we will take our final question from Callum Elliott with Bernstein. Your line is now open.

Thanks for the question. Could you talk, please, about the tax situation for ICOS in Germany? Recognizing that the political landscape is still shrouded in some uncertainty, it does seem like the proposed tax changes would be a material headwind to price mix and profitability next year. So just hoping that you could frame the magnitude of this impact. And then maybe sort of slightly bigger picture, do you see an increased risk of contagion for this kind of big high cost tax increase in other markets?

Well, on Germany, what I can certainly repeat is the fact that it's a kind of mixed feeling that we have about the German decision, because on one side, we are very happy with such a prominent country as Germany putting in their laws the fact that these products are better and should be treated differently than cigarettes. And I think it's really great that this tobacco harm reduction principle is recognized. At the same time, a 20% differential seems too low. Yes, of course, it will have impact as we are progressively impacted by it, and it's too early for me to give an idea of what's going to be the impact next year, but there will be some impact, of course. No, let's be clear, it's not going to derail the trajectory on on high costs and profit growth. But we believe that 20% is not enough. So we are hopeful that at a certain point in time, and it's too early to say, of course, the new coalition is not yet formed, even if I think things are getting clarified, but we'll know whether there is the possibility that starting from this 20% differential, there is a plan to grow it maybe over time. I mean, that could be a possibility. Now, in terms of contagion, what we don't We don't see that today. We see on the contrary when we look at the latest country that are now coming to a differentiated treatment when it comes to Eat Not Burn versus CC. We see normally most of the cases significantly higher even differential versus Germany, so more than 20%. If I take just one example, that's the case in Egypt, for instance. So in the recent decision taken by authorities, they are clearly making a bigger difference, which I think to a large extent is much more in line with the reduction in exposure to toxicants, the 90 to 95%. If you wanted to have a rule to determine what could be the difference, well, maybe that should be the guideline. And I think we are happy to see a number of country, regulator, government moving to differentiate the treatment between CC and Eat Not Burn and taking a big difference on tax treatment.

Thank you.

Thank you.

We have no further questions at this time. I will turn the program back over to Nick Rowley for any additional or closing remarks.

Actually, I think Emmanuel has a few brief remarks.

Yes, thank you, Nick. Just to wrap up with some brief closing comments. First of all, 2021 is on track to be a great year for the growth of ICOS and the financial performance of our business. We see continuation of strong underlying fundamentals, demand, and momentum for the ICOS brand. And last, but certainly not least, despite near-term challenges with device supplies, we remain on track for our three-year growth target supported by a rich, innovative innovation pipeline. So thank you very much for your time today, and we look forward to talking to you soon.

Thank you very much, Emmanuel. That concludes the call. If you have any follow-up questions, you may contact the investor relations team. Thank you again. Have a nice day.

Thank you. Talk to you soon. Bye-bye.

This just concludes the Philip Morris International Q3 2021 earnings call. You may disconnect at any time.

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