Philip Morris International Inc

Good day and welcome to the Philip Morris International Third 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 be also invited to ask questions at the conclusion of the questions from the investment community. I will now turn the call over to Mr. James Bushnell, Vice President of Investor Relations and Financial Communications. Please go ahead.

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2022 third 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 US GAAP measures, and additional smoke-free volume and net revenue 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. 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 excludes 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. I'm joined today by Jacek Olczak, Chief Executive Officer, and Emmanuel Barbeau, Chief Financial Officer. Jacek will join us for the question and answer session. Over to you, Emmanuel.

Thank you, James, and welcome, everyone. Today marks a historic day in our journey towards a smoke-free future, with the certainty that we will have full control of ICOS, the world's leading smoke-free product in the United States, the world's largest smoke-free market, from April 30, 2024. Indeed, today's agreement with Altria removes the potential of a protracted legal process to regain the US right to ICOS, which Altria previously held, subject to performance milestones until 2029. We have ambitious plans for the full-scale launch and rapid expansion of ICOS in the US market. as soon as we take over an efficient time during the transition period to put our commercial model and related organization and infrastructure in place using our wealth of experience from international markets. We see ICOS as the primary vector for establishing a leadership position in the U.S. smoke-free industry, and it will be followed by the other product in our smoke-free portfolio. In this context, Swedish Match offers an immediate position in the whole segment and mutually beneficial synergy at Salesforce level. However, should the offer fail, we can certainly build a robust Salesforce as part of our commercial deployment engine during the transition period. Under both scenarios, we see an accelerated path to profitability with an attractive payback period on our high cost investment given superior US unit economic and the absence of a legacy cigarette business. I will cover this in more detail later. With regard to Swedish Match, we announced this morning an update to our offer with our best and final price of 116 Swedish Krone. Our updated offer retained a 90% acceptance condition which is critical to allow us to capture the full potential of the combination. Now that we are close to the end of the offer period, the increased offer is primarily intended to fairly reflect the higher net value to us of the portion of Swedish match cash flow, which are in US dollars, given currency movements since our initial offer was announced in May. Equity markets, the global economy, and interest rates have also moved unfavorably since then. As such, we believe the updated price, with a premium of 52.5% to the undisturbed share price prior to the initial offer, strengthens the attractiveness yet further for Swedish match shareholders while maintaining strong value creation for PMI shareholders. This is our best and final price, and we hope to complete the transaction next month to achieve full ownership. Turning now to our Q3 earnings, we delivered another very strong performance this quarter with HTU volumes ahead of our forecast and robust growth in total volumes, market share, and combustible net revenues. With adjusted operating income margin in line with expectation, this resulted in total Q3 adjusted diluted EPS of $1.53, close to our all-time high quarterly high, despite notable currency headwinds. ICO's excellent performance continued, with plus 22% growth in pro forma HTU shipment volume, a testament to the continued strengthening of our heat-not-burn portfolio and broad-based growth across key regions. ICO's Illuma continued to drive growth in its launch market. In combustibles, we delivered robust performance with Q3 organic pro forma net revenue growth exceeding plus 4%, driven by accelerated pricing of almost plus 5%. Cigarette shipment volume was essentially stable, and category share grew, supported by Marlboro, showcasing the resilience of the brand despite current economic conditions. Turning now to the headline numbers, our Q3 volumes grew by plus 2.3% on the pro forma basis and by plus 0.6% in total, including Russia and Ukraine. Pro forma net revenues grew organically by plus 6.9% and by plus 6.7% for total PMI. Our total organic net revenue per unit grew by plus 4.5% on the pro forma basis and by plus 6.1% in total, despite lower device revenues. This reflects the increasing weight of high costs in our sales mix and a step up in combustible pricing. Our Q3 adjusted operating income margin declined organically by 100 basis points on the pro forma basis and by 90 basis points in total, consistent with our expectations. As previously communicated, this reflects the recovering device volume, the investment in launching Miluma, including initially higher unit costs, the impact of supply chain disruption, notably due to the war in Ukraine, and increasing global inflationary pressures. Despite these headwinds, our strong top-line growth and ongoing cost efficiency enabled us to outperform our previous currency neutral guidance to deliver adjusted diluted pro forma EPS of $1.33, including unfavorable currency of 23 cents, representing plus 8.3% currency neutral growth. Including Russia and Ukraine, we deliver adjusted diluted EPS of $1.53. Our strong third quarter, combined with a robust H1, supported an excellent delivery for the year to date. I would highlight our strong portfolio volume growth of plus 3.4% and organic net revenue growth of plus 7.7%. Again, reflecting continued strong high-cost performance, pricing, and the recovery of the combustible business in many markets against a pandemic-affected comparison. Smoke-free net revenue made up around 30% of our year-to-date pro forma total, putting us on track to reach our ambition of over 50% by 2025. Our year-to-date operating income margin contracted organically by 110 basis points on a pro forma basis, driven by the factors mentioned previously. We remain on track to deliver cost savings of $2 billion over 2021-2023. $1.5 billion of gross savings have already been delivered, including over $200 million in Q3. This allows us to invest in the business and mitigate increasing inflationary pressures. Year-to-date, currency-neutral adjusted deleted EPS grew by plus 9.7% to $4.11 on the pro forma basis, and by plus 8.8% in total to $4.59, an excellent performance. Now let's turn to the pro forma full year outlook. given the continued growth of icos and robust trends in combustible we are revising our top line forecast upwards to plus two to plus three percent growth in total shipment volume and plus six point five percent to plus eight percent growth in organic net revenues while our top line outlook remains very strong Like many other global companies, we are facing significant inflationary forces in the world economy, and this is reflected in our updated adjusted OI margin forecast. Inflation in our cost of goods remain mid-single digits in the third quarter. However, inflationary pressures are growing as we renew pricing arrangements, notably for certain direct materials, wages, energy, and transportation costs. In addition, the very strong growth of Illuma in Japan and other launch markets has an initial negative margin impact given the higher weight of the consumable and increased cost of both the device and consumable in the first 12 to 18 months of activation. As mentioned previously, the combination of strong demand, global supply chain disruption, and the impact of consuming induction HTU production in Russia means our supply chain is not fully optimized. This has resulted in reduced productivity and a number of additional costs, including an approximate $300 million impact from a significant increase in the use of air freight. As a result, while we continue to expect a rebound in our Q4 adjusted OI margin, partly reflecting higher commercial investment in the prior year. We are now forecasting less expansion than previously expected, with pro forma adjusted organic operating income margin flat to slightly negative for the full year. Despite this change to margin expectations, our top line momentum is strong and we continue to forecast pro forma adjusted diluted EPS growth of plus 10% to plus 12% for 2022. This translates into a pro forma adjusted diluted EPS forecast of $5.22 to $5.33, including an estimated unfavorable currency impact of 87 cents at prevailing rates, notably due to the Euro and Japanese yen. There is a slide in the appendix with further detail on the estimated exchange rate impact. For total PMI, which assumes a full year contribution from Russia and Ukraine, we expect adjusted diluted EPS of almost $6, including an estimated $0.80 unfavorable currency impact. Lastly, given the continued success of ILUMA and the cancellation of terrier production in Russia, I just referenced, we are working to further accelerate our production of induction consumables. As we convert and transition capacity from blade to induction, we incur certain inefficiencies and limits on the availability of Illuma HTUs. We are optimizing our inventory level where possible to minimize any impact on consumer availability. However, these factors are a constraint on our shipment, and we are updating our HTU shipment volume forecast to 89 to 91 billion units for the year. Importantly, this is a short-term supply dynamic. Consumer of tech trends remain strong, and HTU in-market sales volume are expected to further accelerate their growth to over plus 25% in Q4, while also growing sequentially compared to Q3. The cash generation capacity of our business remains exceptional, as shown through the challenges of recent years. Our balance sheet and cash flow remains strong. We delivered operating cash flow of $7.7 billion year-to-date, representing growth of plus 6.5% on a currency-neutral basis. Today, we reconfirm our forecast of around $10.5 billion in operating cash flow for the full year, despite an estimated currency headwind of around $1.3 billion. This means we expect to deliver an excellent $22.5 billion over 2021 and 2022. Cash flow was flooded somewhat in 2021 by $0.5 billion from one of the back and the timing factors of certain cash flow, which benefited 2021 at the expense of 2022. And by a further $0.5 billion of working capital improvement. However, our 2022 forecast demonstrates underlying growth against this exceptional year. I would also like to highlight that US dollar strength has a positive impact on our net debt, given that more than 60% of our financing is in euro, including derivative overlays. This serves to offset the impact on our earnings and, combined with strong cash generation, contributed to $1.5 billion reduction in our net debt since December 2021, which is now below 1.6 times adjusted EBITDA on a 12-month rolling basis. This delivery highlights our ability to maintain a strong balance sheet, pay down debt, and invest in the growth of our business. In addition, we recently increased our annualized dividend for the 15th consecutive year in line with our long-term commitment to retain cash to shareholders. Turning back to our results, our total pro forma shipment volume increased by plus 2.3% for Q3 and plus 3.4% year-to-date. putting us comfortably on track to deliver a total volume growth for the second consecutive year on both a pro forma and total PMI basis. Pro forma HTU shipment volumes grew by plus 21.9% for the third quarter and plus 15.8% year to date. While our shipments have been more volatile this year reflecting the current supply chain dynamic, HTU IMS growth has been consistently strong with plus 18.2% growth in Q3 and plus 19.2% year-to-date with robust performance in the EU region, Japan, and low- and middle-income markets. As I mentioned, we expect a further acceleration of IMS growth in Q4. Focusing now on combustibles, our portfolio delivered robust pro forma organic net revenue growth of plus 4.1% in Q3 and essentially stable pro forma shipment volume. Our pro forma pricing accelerated to plus 4.9% in Q3 as we progressively adjust to the inflationary environment. This reflects notable contribution from Australia, Germany, and the Philippines, and a positive quarterly variant from Indonesia for the first time since Q4 29. We now expect food pricing to be around 4%. Our pro-pharma share of the cigarette category increased by plus 0.2 points here to date. This was supported by Marlboro, where volumes grew by almost plus 4% for total PMI. With a premium position in a challenging consumer environment, this represents an impressive performance from the world's leading cigarette brand. Our leadership in combustible helps to maximize switching to smoke-free products, and we continue to target a stable category share over time, despite the impact of high-cost cannibalization. The positive combination of stable share in combustible and the continued growth of ICOs position us to deliver total market share growth over time. We capture plus 0.5 points of pro forma share gains in Q3 and plus 0.6 points year to date with notable contributions from Italy, Indonesia, Japan, and Poland. Despite increasing competition in many markets, Our leading share of the growing Eat Not Burn category has remained stable since the start of the year at around 75% and grew sequentially in the third quarter. This remarkable achievement is supported by the increasing deployment of a two-tier HTE portfolio, providing adult smokers with an expanding range of innovative and high-quality alternatives to cigarettes. PMI-HTUs again strengthen their position as the second largest nicotine brand in markets where IQOS is present, with a sequential share gain in Q3 of plus 0.2 points to a record 7.7% share, excluding Russia and Ukraine. Focusing now on IQOS performance. we estimate there were approximately 19.5 million IQOS users as of September 30th, excluding Russia and Ukraine. This reflects growth of around plus 0.5 million users in Q3 and plus 2.7 million year-to-date. As shown on the right-hand side of the slide, the third quarter of each year typically experiences slower pro forma user growth due to seasonal factors. The growth of plus 0.5 million this quarter was very robust in a historical context, noting that the high growth in Q3 2020 benefited from a catch-up effect following the relaxation of COVID restrictions on retail location and mobility. Importantly, we expect a strong acceleration in user growth in the fourth quarter of 2022. In the EU region, smoke-free net revenue comprised almost 40% of regional net revenue year-to-date, with a number of markets well above 50%. This performance clearly shows the way towards our ambition to be predominantly smoke-free by 2025. Our EU third quarter HTU share increased by plus 2 points compared to Q3 last year to reach 7.3% of total cigarette and HTU industry volume. I would also highlight the plus 0.2 points sequential increase, which is a notably strong performance given the usual seasonality of the combustible market. Most importantly, adjusted IMS volume continues to grow sequentially and reach a record high of 8.7 billion units on the four-quarter moving average. We expect IMS volume growth to continue in Q4 with a corresponding increase in market share. Please refer to the appendix for additional QCT and market share data. With regard to regulation in the EU, we are encouraged by the increasing number of countries adopting multi-year fiscal framework with clear differentiation of smoke-free products, such as the recent legislation in Romania. We expect the proposal on the EU tobacco exercise directive to be published by year-end and hope for a similar approach. As a reminder, the tobacco excise directive will require unanimous support for approval by all 27 EU member states. Now, let's focus on the performance of ILUMA in the EU region. ILUMA continues to drive user acquisition, the switching of existing users, and accelerated category growth in both Spain and Switzerland. In Q3, both markets experienced another quarter of strong sequential IMS volume growth, with off-tech exit volume of Terria now the clear majority of HTU sales in both markets. We also launched Illuma in Greece at the end of June with promising initial results and introduced the product to Portugal earlier this month. In Japan, The adjusted total tobacco share for our HTU brands increased by plus 2.8 points versus the prior year quarter to 23.6%. As in the EU, Q3 last year saw an optical sequential share decline due to combustible seasonality, making the plus 0.7 point sequential increase this quarter a notable achievement. IMS, again, grew sequentially to reach a record high of 8.3 billion units on a four-quarter moving average. This was driven by the impressive performance of ICO Siluma and the continued growth in key cities such as Tokyo. The hit-not-burn category now represents over one-third of total tobacco in Japan, with ICOs increasingly driving the year's growth. Aiko Sinuma celebrated its first anniversary of the Japan national launch in September and continues to exhibit strong growth due to excellent conversion, consumer satisfaction, and retention rates. Our premium price stereo HTUs continue to grow strongly in Q3 and strengthen their position as both the second largest nicotine brand and largest RLP brand in Japan, reaching an exit of tech share of 14.9%. Encouragingly, Sentia HTUs have also grown rapidly since the initial launch in April and national extension in mid-July, driving consumer acquisition in the mainstream price segment. We've exceeded Q3 with over 25% HTU off-tech share, a record high, and continue to see a long runway of growth in Japan over the coming quarters. In addition to strong high-cost gain in developed countries, we continue to see very promising growth in low- and middle-income markets, which drove around 30% of the company's pro forma HTU growth in Q3. Given the large size of this market, the premium positioning of the existing high-cost portfolio, and the relatively early stage of commercialization, this represents outstanding progress. Strong growth in IMS volume continued, and the pro-pharma share of our HTU brand grew plus 0.9 points versus the prior year quarter to 2.8% in Q3, a robust performance considering the impact of seasonality. This reflects success across many markets, with notable progress in Lebanon, where Q3 of texture in Beirut increased by plus 7 points to 18%, and Egypt, where off-tech share in Cairo is approaching 6%. Further TCT data can be found in the appendix. We are also encouraged by recent positive regulatory development in the Philippines, where the government passed a new law clearly differentiating combustible and non-combustible tobacco products. Smoke-free products will be regulated separately with different health warnings permitted product testing or guided trials, and rules to be established for product communication and point-of-sale activities that will support the switching of adult smokers to better alternatives. In addition, the latest development from our smoke-free innovation pipeline is a new heat-not-burn device that is especially relevant for low- and middle-income markets. It is a simple, convenient, and affordable proposition which can cater to local test preferences without compromising on the reduced risk profile of the product. We are planning pilot city launches in Colombia and the Philippines during the fourth quarter as we further extend our portfolio of smoke-free products to serve different consumer needs. As we continue to innovate, it's critical to integrate sustainability through eco-design principles, circularity and efforts to minimize and manage post-consumer waste. Addressing the environmental impact of our product is a key pillar of our sustainability strategy, which is reflected in our sustainability index and form part of our executive compensation scheme. Our approach to reduce waste related to cigarettes, LRP consumables, device and packaging is covered in a report, case studies and campaign published last month and available via a dedicated microsite on PMI.com. For example, we are progressing well towards our 2025 aspiration of having at least 80% of our shipment volumes covered by markets with anti-littering programs in place for cigarettes and for over 1 million cumulative smoke-free devices to be refreshed or repaired. Moreover, during September, more than 10,000 stakeholders from more than 60 markets joined cleanup initiatives around the world. I am proud of our ESG performance, which continues to be recognized worldwide. Our 2021 low-carbon transition plan and our business transformation strategy were recently nominated for sustainability prizes. And our chief sustainability officer, Jennifer Motlis, was nominated for CSO of the Year at the World Sustainability Awards. Moving now to perhaps most impactful news of today, we are delighted to announce that we will soon have full control of ICOS, the world's leading smoke-free product in the United States, the world's largest smoke-free market. As previously communicated, following the ITC decision last year prohibiting the import of ICOS into the US, we have been in discussion with Altria to find the best path forward. PMI's priority has always been to find a solution that best positions ICOS to realize its full potential in the U.S. as quickly as possible. I am excited to report that we have now reached an outcome that achieves this goal. Let me start by briefly summarizing the key terms of the agreement. From April 30, 2024, PMI will have full control over the commercialization of ICOS in the U.S., allowing us to distribute and sell the product and critically engage directly with adult tobacco users. As part of the agreement, we will pay a total cash consideration of around $2.7 billion to Altria. We believe this agreement represents excellent value to our shareholders. As with the previous agreement, potentially stretching to 2029, this solution provides certainty by avoiding what could have been a protracted and uncertain legal process that could have severely held back the development of ICOS. It provides a clear near-term path to commercializing at scale in the U.S. with the unencumbered backing of PMI food strategy and financial commitment to the product success. ICOS is the world's leading smoke-free product, with remarkable and rapid growth achieved across a wide range of international markets. From a standing start in 2015, ICOS is already a $9 billion annual net revenue business, having created the Attractive Eat Not Burn category and driving its growth. The US is the world's biggest accessible nicotine market by retail value. The estimated retail value of its growing smoke-free market is already around 60% of all international markets combined, excluding China. We have spoken before about our plan to bring a leading portfolio to the US, and we expect IQOS to be at the very core of our US smoke-free future, just as it already is elsewhere. The U.S. opportunity for IQOS is particularly encouraging given the clear demand from American adult smokers for credible smoke-free alternatives to cigarettes. Moreover, current smoke-free products have had limited success in fully switching adult smokers away from cigarettes. In the U.S., there are ample opportunities to build adult smoker awareness. and understanding of smoke-free product offers something that is particularly true for ICOS given our MRTP authorization. We are ready to invest behind ICOS to bring it to market at scale across the U.S., starting with full-scale launches in key cities and regions with a plan to progress rapidly to national penetration. ICOS remains the only inhalable smoke-free nicotine product to have received a modified risk tobacco product authorization from the U.S. Food and Drug Administration. We know from our experience in over 65 markets worldwide that ICOS appeals to adult smokers who have tried the product is strong, as demonstrated by high full switching rate. We have a strong commitment to build awareness and invest behind the category to drive product trial among American smokers. The true potential for high-cost in the U.S. is substantial, as illustrated by the double-digit national shares achieved in just a few years across a number of Asian, European, and other markets, all with varying demographic profiles and adult smoker test preferences. We believe a volume share of 10% of cigarettes and HTUs by 2030 is very achievable with potential to go much further. Importantly, the return on investment for ICOS in the highly profitable U.S. tobacco market is compelling. We estimate the total U.S. industry profit pool at over $20 billion and with average unit margin on U.S. cigarettes more than three times greater than for the PMI average. The payback over the next few years on the consideration paid to Altria looks very attractive. As we do not have a legacy cigarette business in the U.S., the opportunity is purely incremental. This also reflects the current excise tax system with no differentiation for tobacco products versus cigarettes at the federal level and differential on the limited basis in only a handful of states, thus presenting a clear additional opportunity over time. We are already advanced in our plan for ICOS in the U.S. as we prepare for domestic manufacturing and for important regulatory submissions, including for high-cost Illuma, where we plan to file a PMTA in H2 2023. As mentioned previously, we target the first half of next year for the resumption of high-cost domestic supply, which will be available to Atria under our current arrangement up until PMI assumes full commercial responsibility in April 2024. Our proposed combination with Swedish Match would provide certain US sales and distribution capability. However, in the case of failure, we have a clear path forward for ICOS and the rest of our smoke-free portfolio. Indeed, the most critical part of the ICOS commercial model centered on converting adult smokers rather than distribution. In addition, the U.S. has an established distribution and retail landscape with a clear route to market. We therefore also have a concrete plan to proceed autonomously in building fully controlled and managed U.S. sales and distribution capabilities over the next 18 months leading up to April 2024 in order to ensure a successful high-cost rollout and the introduction of other smoke-free products should our Swedish match offer fail. Indeed, we believe today's agreement is fundamental to unlock the U.S. smoke-free market. As we have shared previously, we expect the heated tobacco category to remain the largest and fastest growing in dollar terms internationally. While the e-vapor and to a lesser extent nicotine pouch category have paved the way for smoke-free product in the U.S., we know that heated tobacco comes closest to replicating the experience that smokers enjoy with higher conversion and very low unintended use. To conclude today's presentation, our business delivered strong third quarter and year-to-date performance despite some challenging headwinds, and we expect to deliver another excellent year of double-digit adjusted diluted EPS growth on the pro forma currency neutral basis. Most impressive was the continued excellent high-cost performance with strong shipment volume and IMS growth, reflecting broad-based momentum in the origin, Japan, and emerging markets. We remain excited by the promising results of ICO's ILUMA, our rich pipeline of smoke-free innovation, and plans for further launches of both ILUMA and VEBA in the fourth quarter and in 2023. We continue to accelerate investment in our commercial programs, digital engine, and R&D for long-term growth, as well as behind a number of growth opportunities across category and geography. The return from such investments remains compelling, as demonstrated by the exceptional top- and bottom-line growth delivered over recent years. In addition to growth in smoke-free products, our combustible business continues to perform well with organic net revenue growth and essentially stable pro-pharma shipment volume. Despite accelerated pricing in the current inflationary environment, temporary margin pressure from inflation and supply chain inefficiency is likely to continue in the coming quarters. Importantly, our underlying growth fundamentals remain strong and we look forward with confidence. We have secured our near-term access to the substantial U.S. opportunity for ICOS, also forming the backbone for introducing our broader smoke-free portfolio. We are now advancing on our plan to launch at scale with or without Swedish Match. And finally, we have increased the dividend every year as a public company to the ups and downs of economic and currency cycles. we continue to be steadfastly committed to returning cash to shareholders as we advance toward our ambition to become predominantly smoke-free by 2035. Thank you. And before we start the question and answer session, please note that we are not able to comment on our offer for Swedish Match beyond what has been announced. All materials related to the offer can be found on the website smokefreeoffer.com. And Jacek and I, we are now more than happy to answer your questions.