Philip Morris International Inc

Your program is about to begin. Should you need audio assistance during today's program, please press star zero. Good day and welcome to the Philip Morris International Second Quarter 2022 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 would now like to turn the call over to Mr. James Bushnell, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2022 second quarter results. You may access the release on 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. gap measures and additional heated tobacco unit market data are at the end of today's webcast slides, which are posted on our website. Unless otherwise stated, all references to ICOS are to our ICOS heat-not-burn products, and all references to smoke-free products are to our RRPs. Growth rates presented on an organic basis reflect currency-neutral adjusted results, excluding acquisitions and disposals. Consistent with last quarter, figures and comparisons presented on a pro forma basis entirely exclude PMI's operations in Russia and Ukraine. As mentioned previously, starting in the second quarter of 2022 and on a comparative basis, PMI will exclude amortization and impairment of acquired intangibles from its adjusted results. 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 a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. It's now my pleasure to introduce Emmanuel Barbot, Chief Financial Officer. Over to you, Emmanuel.

Thank you, James. Well, welcome to you in your new role and welcome everyone. Before I begin, I want to reiterate our focus on supporting our employees and their families affected by the war in Ukraine and above all on the safety of our people. We continue to deploy pledge humanitarian support and additional benefits for our Ukrainian employees. As previously announced, we intend to exit the Russian market in an orderly manner as the complexities of continuing to operate in Russia increase, such as supply chain challenges and financial and banking sector restrictions. We continue to actively work on options for doing so in the context of an increasingly complex and rapidly changing regulatory and operating environment, including the requirement to obtain certain governmental approval for any transaction. Turning to our business, we demonstrated strong underlying momentum in the second quarter of 2022 with another quarter of positive volumes supporting better than expected top and bottom line growth. Most impressive was the continued excellent high cost performance and strong Q2 pro forma user growth of more than 1.1 million, demonstrating further sequential acceleration compared to Q1 as device limitation and COVID restriction continue to ease. This reflects strong momentum in the EU region, Japan and developing market. Q2 RRP pro forma net revenues grew by plus 11%, despite the adverse shipment timing impact due to supply chain constraints highlighted last quarter, while HTU IMS volumes grew by plus 20%. ICO Sinuma delivered further impressive results in its first three markets of Japan, Switzerland, and Spain. The acceleration in category growth in these diverse geographies highlights the exciting future growth opportunity across the world, including in the latest launch market of Greece. In combustible, robust Q2 pro-pharma volume growth of plus 2.4% and organic net revenue growth of plus 4.2% were driven by Marlboro share gains, stronger pricing, and the continued recovery of the markets. Maintaining leadership of the cigarette category allows us to maximize the switching of adult smokers to smoke-free alternatives and accelerate our transformation into a predominantly smoke-free business by 2025. We expect the strong underlying momentum of our business in H1 to continue and we are from our organic growth outlook for the year. We are now well on track to deliver two consecutive years of volume growth, confirming our status as a growth company in terms of volumes, organic net revenues, and margins. Despite a substantial currency headwind in 2022, we expect to deliver full-year adjusted diluted EPS of around $6, including Russia and Ukraine. The proposed addition of Swedish Match would further boost our future financial profile. This is a value-creating offer for both sets of shareholders with a compelling strategic and cultural fit, providing an additional opportunity to accelerate our smoke-free future. Turning to the headline numbers, our Q2 volumes grew by plus 3% on the pro-pharma basis and by plus 1.1% in total, including Russia and Ukraine. Proforma net revenues grew organically by plus 6.2% and by plus 5.3% for total PMI, reflecting both the continuous strong growth of ICOS and the ongoing recovery of the combustible business in many markets against a pandemic-affected comparison. As we anticipated and indicated previously, less unfavorable timing of cigarette shipment also played a role, notably due to replenishment of duty-free inventories. Our total organic net revenue per unit grew by plus 3% on the pro-pharma basis and by plus 4.1% in total, despite the expected delay of HTU shipments to Japan, as we managed through global supply chain disruption. This incorporates combustible pricing of plus 3.5% on the pro forma basis or almost plus 5% excluding Indonesia. Our Q2 adjusted operating income margin declined organically by 190 basis points on the pro forma basis and by 150 basis points in total. As expected and communicated in our Q1 quarterly results, this reflects four main factors. First, investment to further expand and match the speed of growth in our smoke-free portfolio. This includes the initial higher cost of Illuma devices and HTUs and the transitory dilutive margin impact of higher device sales as we roll out Illuma and replenish distribution channel as device constraint is to support re-accelerating high-cost user growth. the impact of supply chain disruption, notably due to the war in Ukraine, including around $80 million in additional air freight expenses. Third, inflation of around 4% in our cost of goods, driven by the global pandemic recovery and exacerbated by the war, notably for certain direct materials, wages, energy and transportation costs. And last, a challenging prior year margin comparison, which included substantial cost of goods sold productivity savings. Despite these atypical margin challenges, our robust top-line growth and ongoing cost efficiency enable us to deliver plus 5.6% growth in pro forma currency-neutral adjusted deleted EPS, ahead of expectation to $1.32, and plus 3.8% growth for total PMI to $1.48, including Russia and Ukraine. Looking at the first half of the year now, our volumes grew by plus 4% on the pro forma basis and by plus 2.2% for total PMI. Pro forma revenues grew by plus 8.1% and by plus 7.1% in total, also driven by strong high cost performance and the recovery of the cigarette category. We delivered organic net revenue per unit growth of plus 4% on the pro-pharma basis and plus 4.7% in total, again, reflecting the positive impact of growing HTU volumes and pricing. Our H1 adjusted operating income margin contracted organically by 110 basis points on the pro-pharma basis and 90 basis points in total, driven by the factors mentioned previously. We expect better margin performance in H2, a topic I will revisit shortly. Currency neutral adjusted diluted EPS grew by plus 10.4% to $2.79 on the pro forma basis and plus 9.2% in total to $3.06, an excellent performance given the circumstances. Reflecting this strong momentum, we are Our guidance for 2022. With strong high-cost growth and robust trends in combustible, we foresee an acceleration in our current neutral growth expectation relative to our previous forecast. First, we now expect to grow our total pro-pharma shipment volume by plus 1.5% to plus 2.5% for 2022, achieving another year of volume growth. For pro forma net revenue, we expect to deliver between plus 6 and plus 8% organic growth as compared to the plus 4.5 to plus 6.5% announced previously, despite a greater than anticipated drag from hyperinflationary accounting in Turkey. With a strong recovery in device volume, the increasing contribution of Filuma with initially higher unit cost and ongoing global inflation, we are narrowing our forecast for proforma adjusted organic OIM margin expansion to between 0 and plus 50 basis points. We are also raising our growth outlook for proforma currency neutral adjusted diluted EPS to between plus 10 and plus 12%. This reflects a range of $5.23 to $5.34, including an estimated unfavorable currency impact of $0.80 at prevailing rates, notably due to the euro and Japanese yen. We include the slide in the appendix with further detail on this estimated impact. For total PMI, which assume a full year contribution from Russia and Ukraine, we expect adjusted deleted EPS of $5.90 to $6.05, reflecting similar dynamic to the pro-pharma basis and including an estimated 69 cents unfavorable currency impact. Please note our 2022 forecast assumes no contribution from the proposed combination with Swedish Match, which is expected to close in the fourth quarter of this year, subject to Swedish Match shareholder acceptance and the necessary regulatory approvals. The outlook for high-cost growth is excellent, and we now expect to deliver full-year pro forma HTU shipment volume of 90 to 92 billion units representing the upper half of our previous forecast range. With growth momentum very strong, the main constraint for not further raising our HTU volume target is our production capacity, notably for Illuma HTUs, due to their outstanding initial success and the cancellation of production in Russia as we convert existing production line for induction consumable. We continue to expect excellent HTU growth in the coming quarters with a progressive improvement in Illuma HTU capacity through the first half of 2023. We are prioritizing Illuma launch markets accordingly with further launches planned in Q4 as communicated previously. A notable further update to our outlook is an increase in our operating cash flow forecast to around $10.5 billion, as compared to around $10 billion previously, despite notable currency headwinds. This includes our accelerated pro forma earnings growth forecast and an assumed full year contribution from Russia and Ukraine. We delivered robust operating cash flow growth in H1 of plus 14%, And as shown through the challenges of recent years, the cash generation capacity of our business remains exceptional. While flattered somewhat in 2021 by favorable timing and one-off impact, our revised full-year forecast demonstrates underlying growth again this exceptional year after also accounting for higher inflation-driven working capital requirements and currency. This underlines our ability to maintain a strong balance sheet pay down debt and invest in the growth of our business. Our net debt of $23 billion June 30, 2022 decreased compared to both June and December 2021, despite H1 capital expenditure of $0.5 billion and ongoing dividend payment. Our commitment to our progressive dividend policy is unwavering, and we look forward to the additional cash flow the proposed combination with Swedish Match would bring. We also continue to expect around $1 billion in full-year capital expenditure. Moving now to the pro forma outlook for the second half, we expect to deliver strong top-line growth, organic adjusted ROI margin extension, and further acceleration in bottom-line growth. For Q3, we expect mid-single-digit organic top-line growth driven by ICOS with around $22 billion in pro forma HTU shipment volumes. While there is a tougher comparison for cigarettes and the modest negative impact expected from shipment timing, we expect combustible volume trends to remain resilient by historical standards. Net revenue growth will also continue to be impacted in both Q3 and Q4 by the shift to hyperinflationary accounting in Turkey. While the temporary cost headwinds in Q2 are expected to ease somewhat in the third quarter, we expect this to be broadly offset by a step-up in smoke-free commercial and R&D investment as compared to a devised constraint Q3 2021. This results in an expected Q3 pro forma adjusted diluted EPS range of $1.23 to $1.28, including an estimated adverse currency impact of $0.24 at prevailing rates. We expect a strong Q4 with a rebound in HTU shipment volume due to phasing to be most pronounced as HTU capacity constraints improve. The H2 recovery in our pro forma adjusted OI margin is also expected to be Q4 weighted. Turning back to our results, pro forma HTU in-market sales volume grew strongly by plus 20% for both the second quarter and the first half, notably driven by strong performance in the EU region. As expected, Q2 IMS pro-pharma growth was significantly ahead of shipment volume growth, reflecting the later timing of shipment I mentioned earlier. Our total pro-pharma shipment volume increased by plus 3% for Q2 and plus 4% for H1. As I touched on earlier, this put us well on track to deliver total volume growth for the second consecutive year on both a pro forma and total PMI basis. With the impressive performance of ICOS, heated tobacco units comprise 12.6% of our pro forma shipment volume in H1, or 14% in total, despite the anticipated HTU shipment timing impact in Q2. Our sales mix is also changing rapidly as we aim to become a majority smoke-free company by 2025. Smoke-free net revenues made up almost 30% of our proforma total and exceeded 30% for total PMI in the first half of the year. ICO devices accounted for approximately 5% of the $4.2 billion of proforma H1 RP net revenues. This reflects higher device volume at a lower average price than last year, as we expand our device portfolio with LIL and ILUMA1, and price ladder our blade device portfolio in preparation for the launch of premium position ILUMA. The positive momentum of ICOS continues and is further accelerating in many geographies, providing a powerful driver of revenue and margin growth. We delivered organic growth of plus 8.1% in H1 pro forma net revenues on shipment volume growth of plus 4%. This reflects the twin engine driving our top line in addition to volume. The first is pricing, led by combustible. The second is the increasing mix of RRPs in our business at higher net revenue per unit, which continue to deliver substantial growth. This is an increasingly powerful driver as our transformations accelerate. Let's now turn to the drivers of proforma adjusted OI margin, which contracted organically by 110 basis points. Proforma growth margin decreased by 280 basis points organically, Reflecting the factors I mentioned previously, as we invest in our small business and manage temporary supply chain disruption and cost inflation. This margin headwind was partially offset by better pro forma adjusted marketing administration and resource costs, which improved by 160 basis point organically. This was driven by the positive operating leverage of RP growth and successful cost efficiency program, where we generated around $420 million in gross cost savings, of which approximately $170 million came from COGS productivity and over $250 million from SG&A. With more than $1.2 billion of savings realized by this halfway point, we are well on track to deliver cost savings of $2 billion for 2021-2023. This allows us to reinvest in top-line growth and mitigate inflationary pressures while continuing to deliver margin expansion. We continue to accelerate investment in our commercial programs digital engine and R&D for long-term growth, as well as a number of growth opportunities across categories and geographies. As reflected in our full-year outlook, we expect our operating margin trajectory to improve in the second half of the year as temporary headwind and tough comparison is. Focusing now on combustible, Our portfolio again delivered growth in pro-pharma volume and organic net revenue in Q2. Our pro-pharma shipment volume grew by plus 2.4% against a pandemic-affected comparison notably driven by Indonesia, Poland, and Turkey. In addition, we saw a continued recovery in international duty-free outside Asia as passenger traffic increases. Pro-pharma combustible pricing of plus 3.5% was slightly ahead of our expectation and while we remain cautious on the economic outlook, the pricing environment has been gradually improving. We expect to deliver a similar level of pricing for the full year. Our leadership in combustibles helps to maximize switching to smoke-free products And both the positive Q2 and H1 segment share demonstrate the strength of our portfolio. We continue to target a stable category share over time, despite the impact of high-cost cannibalization. This year marks the 50th anniversary of Marlboro becoming the world's leading cigarette brand. With the return of social consumption occasion, Marlboro volumes grew plus 7% year-over-year in H1, with category share again surpassing 10% on the pro forma 12-month rolling basis. Of course, our longstanding success in building Marlboro's brand equity is a strength we are now smoke-free product as we make excellent progress with ICOS as the undisputed global smoke-free leader. The positive combination of a stable share in combustible and the continued growth of ICOS positions to deliver total market share growth over time. We capture plus 40 basis points of pro-pharma share gain in Q2, including gains in duty-free, Italy, Japan, and Turkey. Moreover, PMI-HTU strengthened their position as the second largest nicotine brand in markets where ICOS is present, with a 7.5% share, excluding Russia and Ukraine. Moving now to ICOS performance. We estimate there were approximately 19 million ICOS users as of June the 30th on the pro forma basis. This reflects very strong growth of over plus 1.1 million users in Q2 and plus 2.2 million in H1, a record first half high on this basis. The acceleration of high-cost user growth compared to both Q1 and last year was driven by the reactivation of acquisition and retention programs in many markets as device supply constraints receded, as well as the impressive start of Eicosiluma. While device supply constraints have eased in recent quarters, this is largely due to the success of our own proactive effort. The global supply of semiconductors remains tight, and we continue to closely monitor and manage the situation. In the EU region, we are now approaching the milestone of 9 million high-cost users, reflecting stepped-up commercial activities to drive acquisition and retention, along with the launch of Illuma in Switzerland and Spain. Our second quarter HTU share increased by plus 1.6 points to 7.1% of total cigarette and HTU industry volume. As noted in prior years, sequential share compared to Q1 was affected by the usual seasonality of the combustible market, with the additional element of a strong year-over-year combustible recovery this quarter. Most importantly, IMS volume continued to exhibit robust sequential growth, and we expect this to continue in the second half. The strong performance includes excellent user and volume growth across the region, with notable contribution from Italy and Poland. Now, to give some further color on our progress in the region, this slide shows a selection of the latest key city of textures in Q2. Despite the denominator effect of the combustible category I just mentioned, share results remain very strong. Most impressive is Vilnius, the first city in the world to surpass 40% share, while Athens, Budapest, and Rome are in the mid to high 20s. Elsewhere, we are especially pleased by the results in London, Vienna, and Zurich. In Japan, Aiko Siluma is driving, and our share of market continues to increase in key cities such as Tokyo. Most importantly, our IMS volume trends remain strong with continued sequential growth. As indicated last quarter, Q2 shipments were lower due to timing factors and should recover in the second half with a weighting toward Q4. The adjusted share for our H2 brands increased by plus 1.9 points to a record 22.9% in Q2 despite seasonality. While we are very pleased with these results, our share performance could have accelerated even further. The combustible category was notably resilient in the quarter, and our rollout of mainline price Sentia HTUs for use with Illuma was slightly slower than initially planned. However, early results were encouraging. Sentia is designed to cater to its consumers switching to Illuma and more price-conscious legal-edge smokers. We also observed an increase in legal-edge users switching from low-price competitive heat-not-burn products. We estimate users of competitive offerings to have less average daily consumption due to lower food consumption, which we believe Illuma should improve over time. The heat-not-burn category now represents around one-third of total tobacco in Japan, with ICOs increasingly driving this year's growth. In addition to strong progress in developed countries, we continue to see very promising high-cost growth in low- and middle-income markets. The pro forma share of our HTU brand in the 28 such markets launched by December 31, 2021, continued to grow and reach 2.9% in Q2, reflecting sustained growth in IMS volume. Given the large size of this market, the premium positioning of the existing ICOS portfolio, and the relatively early stage of commercialization, this represents outstanding progress. A prime example of this are Lebanon, where Q2 off-tech share in Beirut increased by plus 8.1 points to 17.4%, and Egypt, where off-tech share in Cairo reached around 5%, launching less than one year ago. Other notable successes include the recently launched market of Morocco and Tunisia, as well as Georgia, Jordan, North Macedonia, and the Philippines, despite pandemic restrictions in Manila. Moving now to ICOS Iluma, which continues to drive increased conversion and retention rate across initial launch markets.