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.