Philip Morris International Inc

Good day, everyone, and welcome to the Philip Morris International Second Quarter 2023 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 2023 second quarter results. The press release is available on our website at PMI.com. A glossary of terms, including the definition for smoke-free products, as well as adjustments, other calculations, and reconciliations to the most directly comparable U.S. gap measures for non-gap financial measures cited in this presentation and additional net revenue data are available in Exhibit 99.2 to the company's Form 8K dated July 20, 2023 and on our Investor Relations website. Growth rates presented on an organic basis reflect currency-neutral adjusted results excluding acquisitions and disposals. As such, figures and comparisons presented on an organic basis exclude Swedish Match up until November 11, 2023. 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 is now my pleasure to introduce Emmanuel Barbeau, our Chief Financial Officer. Over to you, Emmanuel.

Thank you, James, and welcome, everyone. Our business delivered outstanding performance in the second quarter of 2023, exceeding our expectations to reach a record high quarterly adjusted deleted EPS of $1.60. This was driven by impressive VIN and high-cost growth coupled with strong combustible results. We delivered total cigarette and HTU shipment volume growth of plus 3.3%, putting us well on track for our third consecutive year of positive volumes. This excellent result underpinned double-digit organic top-line growth and high-teens currency neutral adjusted deleted EPS growth. We also expanded our leadership in smoke-free product in the period. Firstly, ICO's strong momentum continued with adjusted in-market sales volume ahead by plus 16% and shipments up by plus 27%. This reflects very good user growth of plus 1.4 million in the quarter and continued strong traction across the world. This is increasingly driven by ICOS Iluma, which is now available in 23 markets, representing around two-thirds of our ICOS business by volume. Secondly, and now two full quarters after the Swedish match acquisition, Zinn is delivering an exceptional acceleration to our smoke-free business. U.S. volumes grew by over plus 50%, including a notable step-up in June. We are delighted with this performance. Our combustible business also delivered better than expected results with over plus 7% organic net revenue growth after a very robust quarter for pricing and resilient volume. This was a key contributor to the strong plus 7% organic operating income growth with a plus 200 basis point sequential improvement in our adjusted operating income margin. Turning to the headline numbers, positive volumes supported very strong organic top-line growth of plus 10.5%, with continued excellent high-cost momentum and a further acceleration in combustible pricing. This does not include the remarkable plus 19% pro forma ex-currency top-line growth of Swedish Match, led by Zin, with combined pro forma X currency net revenues increasing by plus 11.1%. Our total reported currency neutral net revenues grew by plus 19%. Our organic net revenue per unit grew by plus 7%, driven by the increasing proportion of high-cost HTUs in our sales mix and combustible pricing. Due to these positive factors, adjusted operating income grew by a very robust plus 7% organically, despite continued inflationary headwinds. This excludes the tremendous growth of ZIN, and starting in Q4, our organic results will include Swedish match. Adjusted OI margins improved plus 210 basis points sequentially, and while still organically lower year-on-year by 140 basis points, this better-than-expected performance was notably supported by combustible strength and favorable timing of certain costs. We also increased our participation in the below Tier 1 segment in Indonesia, which now represents close to 40% of its industry volumes and is slightly dilutive to our margins. This organic delivery, including the favorable timing of cost, combined with exceptional June ZIN volume and a lower tax rate, allowed us to outperform our most recent Q2 forecast. We delivered adjusted deleted EPS of $1.60, representing plus 16.9% growth, excluding an unfavorable currency impact of 13 cents, notably due to the Japanese yen. While the first quarter of the year contained some exceptional headwinds and distortions due to timing and comparison effects, our business delivered a strong first half, including volume growth of plus 1.1%. Organic net revenues grew by plus 6.8%, with Swedish Match's excellent externancy pro forma net revenue growth of plus 17% for H1, demonstrating its growth accretion to our business. combined pro forma currency neutral net revenue increased by around plus 7.5%. Following peak margin headwinds and a notable operating income decline in the first quarter, the strong improvement in Q2 narrowed the H1 organic decline to minus 2%. As in Q2, this exclude Swedish match which delivered an excellent profit performance and made a significant contribution to our adjusted OI margin. We expect continued strong reported and organic operating income growth in the second half. Despite these headwinds, we delivered plus 5.9% growth in currency-neutral adjusted deleted EPS to $2.98 in H1, providing a strong platform for the second half of 2023 and beyond. Let me now walk through the mechanics of our Q2 net revenues. While not included in our reported shipment volume growth of plus 3.3%, Swedish match smoke-free volume grew by plus 15%, providing impressive accretion to our overall growth profile. Combustible and HTU pricing contributed plus six points of growth. This primarily reflects combustible strength, partly benefiting from timing effect. As in Q1, HTU pricing was impacted in Japan and Germany by the annualization of 2022 excise tax increase, and in the case of Japan, the transition to Illuma. These factors will have less impact in the second half as annualization recedes. We also continue to expect greater visibility on the likely outcome of the court ruling related to the German tax surcharge towards the end of the year. The increasing proportion of HTUs in our business, again, contributed positively, reflecting higher net revenue per unit, partially offset by unfavorable geographic mix. The positive mix impact of HTUs, overall volume growth, and pricing are powerful drivers of our transformation and growth. Let's now turn to growth margins. While the year-on-year trajectory remained negative, we saw improvement versus the first quarter driven by strong growth fundamentals. Indeed, we achieved sequential improvement of 1.2 percentage points despite increased inflationary pressures as top line growth accelerated and supply chain disruption and ILUMA-related factors started to dissipate in the quarter. In addition, cost phasing and the geographic mix of inventory movement, notably for HTU in Europe, increasingly normalized after an adversely affected Q1. Our ICO business contributed positively to our growth margin in Q2, and we expect this to continue, partly mitigating combustible. We expect further improvement in our year-on-year growth margin trajectory in H2, as headwinds continue to subside, ZIN's outstanding growth continues and the underlying driver of our transformation accelerates. As expected, SG&A growth was much closer to net revenue growth in Q2 and at a more normalized growth rate with regard to our full year expectation. Indeed, with such a strong top line in Q2, SG&A costs were lower as a percentage of net revenues. While we continue to invest in ICOS and ZIN, Our successful cost efficiency program continues to deliver, helping to finance growth investment and mitigate inflation, which remains a headwind. With $1.9 billion of growth savings realized to date, including $820 million from SG&A, we are on track to achieve our 2021-2023 $2 billion target ahead of plan. Turning now to the 2023 outlook, we are raising our currency neutral top and bottom line growth forecast. We aim to be a growth company starting with volumes. In 2023, we expect to grow total volume for the third year in a row, even before factoring in the excellent progress of Swedish Match portfolio. As part of this growth, we are reiterating our targeted HTU shipment range of 125 to 132 billion, while we expect a cigarette volume decline of 1.5 to 2.5%. We are increasing our organic net revenue growth forecast to plus 7.5 to plus 8.5%, reflecting the continued momentum of ICOS, the resilience of our combustible business, and the ongoing excellent growth of ZIN, which we expect to contribute positively in Q4. We expect strong organic operating income growth in the remainder of the year to support H2 margin expansion, despite the headwinds previously mentioned and certain technical impacts. These relate to the increased use of third-party manufacturing in a few markets, such as Indonesia and Ukraine, and the related growth of the below Tier 1 segment in Indonesia I already mentioned. The full year estimated impact of this factor is around 40 basis points on our adjusted OI margin, and without this impact, we would expect to be broadly in the middle of our forecast organic margin range. On top of this organic evolution, we expect Swedish Match to add around 50 basis points of accretion. Our front-top line and OI outlook allows us to raise our forecast for currency-neutral adjusted diluted EPS growth to plus 8% to plus 9.5%. This translates to a revised range of $6.13 to $6.22, including $0.33 from unfavorable currency at prevailing exchange rate, notably due to the Japanese yen and Russian ruble. This forecast continues to assume around $150 million for incremental investment in the U.S. and our wellness and healthcare business. It also assumes around $1.2 billion in net finance costs, which includes higher interest on variable debt, partly offset by better returns on cash deposits. As previously mentioned, our forecasts do not assume any contribution from a potential favorable ruling on the Germany tax surcharge. Focusing on the second half in more detail, we expect strong performance on all key metrics as smoke-free products deliver an increasingly positive impact. In Q3, we forecast high single-digit organic top-line growth, with HTU shipments of 31 to 33 billion units, and adjusted diluted EPS of $1.60 to $1.65, including six cents of unfavorable currency at prevailing exchange rate. Looking ahead to Q4, we expect notably strong reported and organic OI growth, as certain inflationary impacts are annualized, and we increasingly benefit from an optimized Illuma supply chain and consumables. As I mentioned, Swedish Match will also be included in our organic figures during the quarter. The exceptional growth of ZIN is clearly margin accretive, as visible in our adjusted H1 figures. Turning back to our results, our total shipment volume increased by plus 3.3% for Q2 and plus 1.1% year-to-date. HTU shipment volume grew by plus 26.6% in Q2, to reach 31.4 billion units, notably driven by continued strong performance in Europe and Japan. In addition to fundamental strengths, HTU shipments to Japan were boosted in Q2 by around 2 billion units as we increased sea freight, with corresponding increase in inventory level. As I mentioned earlier, total PMI adjusted IMS volume of HTUs increased by plus 16% in Q2, continuing the excellent trends in Q1. H1 shipment volume grew by plus 18.5%. Notably, this does not include the excellent growth prospect of oral nicotine, for which shipment volume grew by plus 14% in Q2 and plus 12% in H1 on a pro-forma basis. Cigarette volume declined by a modest 0.4% in Q2, with notable support from Turkey and Egypt, and by 1.7% for H1, reflecting a solid category share performance in a resilient category, despite stepped-up pricing. Our smoke-free transformation continues to progress rapidly. Due to the continuous impressive performance of ICOS, inter-tobacco units comprise 16.4% of our total shipment volume in H1 as compared to 14% in the first half of 2022, despite a resilient cigarette category. Including all smoke-free products, this would be close to 18%. Powered by ICOS and VIN, smoke-free product made up 35% of our adjusted net revenue in H1 compared to 30.9% for the same period in 2022. ICOS devices accounted for approximately 4.5% of our H1 inhalable smoke-free net revenue. Focusing now on combustible. portfolio delivered strong organic net revenue growth of plus 7.4% in Q2 and plus 5.2% in H1. This reflects strong Q2 pricing with a notable contribution from Indonesia and the Philippines. While we don't expect the exceptionally strong Q2 pricing of 9.4% which benefited from timing factors to be fully replicated in H2, we now forecast a full-year increase of plus 7 to plus 8%. Our cigarette category share grew by plus 0.7 points in Q2 on a year-over-year basis, including contributions from Duty Free, Egypt, and Turkey, and by plus 0.1 points in H1, resulting in only modest volume declines. Our leadership in combustible helps to maximize switching to smoke-free products, and we have fully achieved our ongoing objective of stable category share over the last 18 months, despite the impact of high-cost cannibalization. The combination of stable share in combustible and the continued growth of our leading smoke-free brands position us to deliver total market share growth over time. We captured plus 1.1 points of international cigarette and HTU share in Q2, and plus 0.5 points in each one, with notable contributions from Turkey and Japan. Impressively, despite increasing competition in many markets, our volume share of the growing heat node burn category remains stable at around 75%. This is supported by ongoing Illuma market launches and increasing focus on our two-tier HTO portfolio, providing adult smokers with an expanding range of innovative and high-quality alternatives to cigarettes. TMI HTUs, again, strengthen their position as the second-largest nicotine brand in markets where ICOS is present, with a sequential share gain in Q2 of plus 0.2 points to record 9.2% shares. We estimate there were 27.2 million high-cost users as of June 30. This reflects excellent growth of plus 1.4 million adult users in Q2, with notable progress in Japan and Europe, in addition to a broad range of other geographies. While fundamentals remain very strong, I remind you that Q3 user growth can often be below the average for the year, due to the seasonal factors evident in prior years. I will now turn to ICOS in the Europe region, where we are approaching a milestone of 12 million users. This reflects the further rollout of ILUMA, which is now available to around 70% of ICOS users in the region, and the extension of our two-tier portfolio. As an illustration of its progress, Terria is already close to 100% of our HTU in market sales volume in the first launch market of Spain and Switzerland. Our second quarter HTU share increased by plus 1.6 points year over year to 9% of total cigarettes and HTU industry volume. While sequential share is, as usual, optically affected by the seasonality of the cigarette category, adjusted IMS volume continued to exhibit robust sequential growth and reached a record high on the four-quarter moving average. This reflects strong year-on-year growth of plus 20% in Q2, outstripping the plus 11 growth in HTU shipments, which were affected by some residual effect from the inventory dynamic seen in Q1. We expect robust growth in HTU shipments, adjusted IMS, and overall region-organized revenue in the second half. We continue to be encouraged by the increasing number of European countries adopting multi-year excise tax plans with clear differentiation of smoke-free products. Over half of EU member states have now passed multi-year plans. Also in the EU, a number of member states are currently transposing the delegated directive withdrawing the heated tobacco product exemption from the flavor ban into national legislation. The ban is scheduled to come into effect on October the 23rd, and we will be adjusting our HTU portfolio as required in line with this transposition. While short-term volatility is possible, we do not expect a significant change in the structural growth of the category. To give some further color on our continued progress in the region, this slide shows a selection of the latest key cities of tech shares. The success of ICOS continues across a diverse range of geographies, from Western, Southern, Central, and Eastern Europe, including markets with and without Illuma. Despite the denominator effect of the combustible category I just mentioned, share results remain very strong. We are very pleased with trends in Rome, showing a sequential step up to 28% share following the Illuma launch. Robust progress in London and Munich also bodes well for these two key markets. While the Q2 2022 comparison for sharing genius was held by the popularity of certain bundle offers, the share of over 40% remained impressive and underlying of tech continues to grow. In Japan, ICO Sinuma continues to drive impressive growth momentum. Smoke-free products made up over 75% of our Japan net revenue in H1, clearly showing the path for the broader company. Adjusted total tobacco share for our HTU brands increased by 3.4 points in Q2 to 26.3%, further strengthening Terea and Sentia's position as a clear number one and two heat not burn brands, despite intensified price competition for mid and low price offering. Importantly, adjusted IMS volume again grew sequentially, reaching a record high of 9.3 billion units on the four-quarter moving average as ICOs outgrew the heat not burn category. In addition, to this excellent consumer trend, our Q2 shipment to Japan also benefited from progressively switching back to sea freight during the quarter. In addition to strong high-cost gains in developed countries, we continue to see very promising growth in low- and middle-income markets. This slide highlights a selection of Q2 key city of tech shares across markets in Eastern Europe, Africa, Asia, and Latin America. Notable ongoing successes include Egypt, with scale of tech shares surpassing 8.5%, and Bulgaria, with off-tech share in Sofia exceeding 15%, despite the usual impact of seasonality that I mentioned. We continue to see robust off-tech growing growth across these important future markets. Now, moving to Swedish Match. which is meaningfully accelerating our smoke-free growth trajectory. As covered earlier, the business delivered outstanding currency-neutral net revenue growth of plus 19% in Q2 and plus 17% in H1. This means that in the first half of the year, Swedish Match has added 70 basis points of currency-neutral growth to our pro-format upline and plus 60 basis points to our adjusted OI margin. In the U.S., Zinn delivered another exceptional quarter with volume growth of over 50%, reflecting positive momentum across the country. Elsewhere in smoke-free, recent trends of share gain in U.S. moistness, as well as category mix headwinds in Scandinavia, broadly continued. The cigar business performed well, with Q2 organic net revenue growth of plus 16%. This reflects ongoing share gains despite being an early mover on category pricing. I would like to again congratulate and thank all the Swedish Match employees for continuing to deliver terrific results as we thoughtfully integrate our activities, which is progressing very well. Looking at VIN US performance in more detail, exceptional year-over-year volume growth in CAN of plus 53% also reflect a plus 22% sequential increase versus Q1 2023. This accelerated growth reflect progressive increase in distribution and a broad nationwide step-up in store velocity as a category against strong traction with adult nicotine users for its convenience and pleasurable experience. This includes California, which implemented a statewide flavor ban in December. While such elevated rates of growth may not continue indefinitely, the structural indicators remain very encouraging. Impressively, ZIN category volume share grew plus 2.2 points compared to prior year and plus one point sequentially, despite continued discounting from less premium offerings. Retail value share also grew to 76.8%, highlighting its premium positioning and superior brand equity. Now, let me provide an update on our innovation and expansion plan as we further accelerate our smoke-free transformation. First and foremost, the global rollout of high-cost ILUMA continues to be a top priority. We launched ILUMA in six markets in Q2, and with HTU manufacturing constraints now normalized, we aim to be present in around 50 markets by the end of the year. the most significant opportunity to drive accelerated growth is in the U.S. We are investing behind the scenes and readying our organizational and commercial capabilities for the launch of ICOS in Q2 next year. As mentioned in today's release, we are also on track for ICOS ILUMA PMTA and supplemental MRTPA submission in Q4 2023. Our philosophy on the U.S. remains unchanged. We seek to accelerate our top line with ICOS and ZIN, supported by disciplined investment and leveraging both our extensive experience in small free products and Swedish-matched infrastructure and knowledge, while continuing to deliver strong bottom-line growth for PMI. Our pilot city launches for bonds in the Philippines and Colombia continue to progress well. The learning from this market will be integrated as we roll out more broadly starting next year. The international expansion of nicotine pouches remains a key medium-term opportunity, notably for Zyn as the world's leading brand. We are now preparing for the relaunch of Zyn in several markets. In eVapor, Our refocused approach in select market is progressing with VIVE-1, our newly designed pod-based system introduced in four markets, and VIVE-NOW, our disposable product, in six markets. Now, let me discuss our wellness and healthcare segments, starting with its first clinical trial result for our inalienable aspirin product. While it was observed that the experimental product had a rapid onset of effect, which is a key medical advantage sought, there was significant variability in in-air dose among subjects. The study was therefore deemed unsuccessful, and as a result, product design improvements are required. Our plan was to find this product with the FDA later this year. However, additional time is now required, and the outcome is therefore less certain. In addition, the CDMO business has been facing slower than anticipated development, including cost-related challenges. Consequently, we recorded a non-cash goodwill impairment from our annual assessment as detailed in today's release. While these elements will postpone the achievement of our 2025 aspiration to reach over $1 billion of net revenue from wellness and healthcare products, they will result in a corresponding decrease in the level of investment in 2024. Our ambition to build and monetize our product pipeline are unchanged. As in the early days of developing ICOS, certain headwinds are to be expected, and the 2021 acquisition in this segment has provided us with unique and enabling R&D capability. We remain committed to developing our wellness and healthcare business and continue to see attractive mid- and long-term growth potential on many fronts, such as inalienable drugs, NFC, and consumer wellness products, including non-recursional cannabinoids, in line with applicable regulatory requirements. We also aim to accelerate Victoria's growth and will be exploring potential partnerships to enhance its CDMO business. We plan to discuss all these topics, including our plan for ICOs in the U.S., and a full update on our wellness and healthcare business at our investor day on the 28th of September in Lausanne, Switzerland. Moving now to sustainability. Addressing the product health impact of combustible products by switching adult smokers to smoke-free products, such as ICOs and Zines, remains our most critical priority. This transformation is at the core of our strategy, driving accelerated growth and returns over time from a more sustainable business. In addition, we remain committed to delivering best-in-class progress in other key sustainability areas. With our extensive agricultural and manufacturing supply chain, human rights are a very important responsibility for our company. We released our first dedicated report on the topic last month, detailing our strategy to promote, respect, and protect human rights and the progress to date in implementing our human rights commitments. Our performance on human rights is included in the 19 KPIs of our sustainability index, which comprises 30% of executive long-term equity compensation weighted towards our product transformation. Our goal is to conduct comprehensive human rights impact assessments in our 10 highest risk markets by the end of 2025. These help us better understand and address our impacts, and we are making excellent progress with seven completed to date. Addressing climate change is another priority for us, And I am pleased to share that PMI was included in the Forbes first ever net zero leaders list, ranking seventh overall for all U.S. public company higher than any other consumer product or service company. To conclude today's presentation, we delivered a very strong first half despite the number of headwinds, putting us on track for the third consecutive year of positive volume and organic net revenue growth of over plus 7%. The powerful trajectory of our smoke-free business gives us confidence in a strong full-year performance with excellent operating income growth. Outstanding momentum continues for Icos and Zin, the world-leading heat-not-burn and oral nicotine brands, and we have exciting plans to further grow oral nicotine pouches in the U.S. and internationally. along with the U.S. commercialization of ICOs next year. Importantly, we remain steadfast in our commitment to generously reward our shareholders, including through our progressive dividend policy. In short, our smoke-free transformation continues to deliver sustainable growth. We look forward to sharing more with you on the next phase of our transformation at our investor day on September the 28th. Thank you very much, and we are now delighted to answer your questions.