Philip Morris International Q1 2022 Earnings Call Transcript

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Provided by Quartr
April 21, 2022

There are 10 speakers on the call.

Operator

Good day, and welcome to the Philip Morris International First Quarter and 2021 Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by Philip Morris International Management and the question and answer session. Conclusion of the question and answer from the investment community. I would now like to turn the call over to Mr. Nick Rollie, Private Vice President of Investor Relations Financial Communications, please go ahead, sir.

Speaker 1

Welcome and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2022 Q1 results. You may access the release on www.pmi.com. Glossary of terms, including the definition for reduced risk products For RRPs as well as adjustments, other calculations and reconciliations to the most directly comparable U. S.

Speaker 1

GAAP 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 IQOS are to our IQOS heat not burn products and all references to smoke free products or to our RRPs. Growth rates presented on an organic basis reflect currency neutral adjusted results excluding acquisitions. Figures and comparisons presented on a pro form a basis entirely exclude PMI's operations in Russia and Ukraine. In the Q3 of 2021, we acquired Fertin Pharma, Vectura Group and Otitopic.

Speaker 1

On March 31, 2022, we launched a new wellness and healthcare business, Vectura Fertin Pharma, which consolidates these entities. The operating results of this new business are reported in the other category. Business operations of our Wellness and Healthcare business are managed and evaluated separately from the geographical 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 a review of the various factors that could cause actual results to differ materially from projections or forward looking statements.

Speaker 1

It's now my pleasure to introduce Jacek Golczyk, Chief Executive Officer and Emmanuel Babbo, Chief Financial Officer. Over to you, Lache.

Speaker 2

Thank you, Nick, and welcome, everyone. I hope you all are safe and well. Recent months have been extremely challenging for many of us Given the tragic events related to the war in Ukraine, I would like to express our sadness and solidarity for the people of Ukraine. Our primary concern is for our employees and their families, and we have been doing everything we can to support them with 3 priorities. 1st, evacuating our colleagues.

Speaker 2

We have evacuated over 1,000 colleagues and family members the country and supported more than 2,700 hours to move from conflict zones to locations away from the heaviest fighting. 2nd, we are delivering critical aids to people that cannot leave or who decided to remain in Ukraine. And 3rd, we are providing accommodation, immediate assistance and a path forward to those who left the country. In addition, we have already contributed around $10,000,000 in funds and donated essential items across the country directly to humanitarian organization and through our own employee led initiative projects with heart. This includes providing medicine, food, clothes and a variety of other items to our colleagues and to the broader population, The purchase of 25 ambulances and the setup of a mobile hospital.

Speaker 2

Based on our current visibility, We estimate an additional cost of around $25,000,000 for additional support to employees this year. Our colleagues in neighboring countries continue to provide vital support to all people arriving from Ukraine to seek refugee. Our heartfelt gratitude goes to everyone involved in this generous effort to help at such a difficult time. In terms of the impact on our business operations, production at our Ukraine manufacturing Facility in Kharkiv remains suspended. While business activities in Eastern Ukraine have been mostly heavily impacted, We have seen some resumptions in areas where conditions allow as we seek to maximize product availability and service to consumers using existing inventories on hand.

Speaker 2

We are also now planning to import products from other manufacturing location, Although this may involve higher costs, we continue to pay salaries to our Ukrainian employees and to provide substantial in kind support to them and their families. As communicated in our March 24 press release, PMI's Board of Directors and senior executive team Working on options to exit the Russian market in an orderly manner in the context of a complex and rapidly changing regulatory and operating environment. This is no easy task In view of recently introduced complex legislation, but we are committed to seeking a viable path to exit the market while supporting our employees in Russia for this period. It is also clear that we cannot Continued business as usual in light of the regulatory and supply chain disruption, which has already impacted the Russian business in Q1. We have taken concrete steps to scale back our operations, such as the cancellation of all new investments and product launches, including IQOS ILUMA and IQOS V.

Speaker 2

We are delisting 25% of our cigarette products, including Marlboro and Parliment SKUs. We have also canceled $150,000,000 investment in capacity to ultimately manufacture more than 20,000,000,000 tera sticks for IQOSILUMA in our Russian factory. Clearly, the impact of the conflict has also created disruption in global supply chains and exacerbated inflationary However, the Q1 performance and outlook for our business, Excluding Russia and Ukraine, remains strong. On a reported basis, our outlook conservatively assumes No further contribution from Russia or Ukraine from April 1. To provide a consistent view, given the uncertainty and volatility of these two markets, we will now also provide adjusted results and guidance on a pro form a basis excluding Russia and Ukraine from both the prior and full current year.

Speaker 2

I will now hand over to Emmanuel to cover this in more detail.

Speaker 3

Thank you, Jacek. We delivered a very strong performance in Q1 with double digit organic net revenue and currency neutral Adjusted diluted EPS growth on a pro form a basis, excluding Russia and Ukraine, from both the current and prior year quarter. Overall currency neutral results were also ahead of our expectations. Our IQOS business delivered Q2 continuing the reacceleration since last quarter as device supply constraint continued to ease. Our IQOS user base grew by more than €1,000,000 excluding Russia and Ukraine, marking a very strong performance.

Speaker 3

RRP pro form a net revenues grew by +23percentwithpro form a smoke free net revenue over 30% of the total company. Importantly, pro form a HTU shipment volumes grew plus 18% compared to the prior year quarter. This reflects excellent progress in the EU region, continued growth in Japan as well as over 50% growth in low and middle income markets. PMI HTUs are now the 2nd largest nicotine brand in markets where IQOS is Present as our efforts on innovation, portfolio and geographic expansion drive consumer trial and adoption. The impressive start for IQOSILUMA continues in Japan and Switzerland with very encouraging initial take up in our latest launch market of Spain.

Speaker 3

The initial success in these 3 very different markets reaffirms our confidence in Illumas, an exciting future growth driver for our company. Meanwhile, our combustible business performed robustly, exceeding our objective of stable category share and delivering positive volume and organic net revenue growth. In addition to supporting strong financial performance, this also enhances Our ability to maximize the switching of adult smokers to smoke free alternatives. Overall, our business is off to a strong start. And while currency is unfavorable in 2022, we expect to deliver another year of robust organic top and bottom line growth.

Speaker 3

Turning now to the headline numbers. Our Q1 net revenue grew organically by plus 9% in total and plus 10% on a pro form a basis. This reflects total volume growth driven by the underlying strength of IQOS, the ongoing recovery of the combustible business in many markets against pandemic affected comparison and some positive timing impact, including inventory movements. Our total organic net revenue per unit grew plus 5.3% and by plus 4.9% on a pro form a basis, driven by the increasing proportion of IQOS HDUs in our sales mix, higher device volumes and pricing. Combustible pricing was above expectation at +2.9 percent pro form a or around+6 percent excluding Indonesia.

Speaker 3

Our total Q1 adjusted operating income margin declined organically by 30 basis points and by 40 basis points, excluding Russia and Ukraine. This reflects lower gross margin compared to a tough prior year comparison, where productivity was higher mostly due to timing factors. Flagged in our full year earnings, Q1 margins were impacted by higher device sales for increasing IQOS user acquisition, channel replenishment and IQOS Inuma. As mentioned previously, the unit cost and weight of Inuma consumable And device cost is initially higher as we ramp up production with improvement expected from next year. Inflation in certain element of our supply chain, including energy, wages and direct materials and An increase in the use of airfreight was also exacerbated by the impact of the war in Ukraine.

Speaker 3

Despite these temporary margin challenges, we saw positive effects of the increasing size of IQOS, pricing and cost efficiency combined with our strong net revenue growth. This enabled us to deliver adjusted diluted EPS of 1.56 including unfavorable currency of EUR 0.23 representing plus 14% currency neutral growth. This was comfortably ahead of our currency neutral expectation, even accounting for timing benefit of around 0 point 06 dollars Excluding Russia and Ukraine, our pro form a adjusted diluted EPS of 1.46 grew by +16%. Turning now to our 2022 outlook. As Jacek mentioned, given the lack of visibility on Russia and Ukraine, we are now providing an adjusted outlook on a pro form a basis, excluding these two markets for the entire year.

Speaker 3

With our underlying business reaccelerating, our growth fundamentals remain strong. Importantly, we expect to deliver organic net revenue growth of +4.5 percent to+6.5 percent compared to 2021 pro form a adjusted net revenue of $29,200,000,000 This is above our previous forecast trajectory for total PMI despite an approximate half point drag from the shift to hyperinflationary accounting in Turkey. This range incorporates the risk of supply chain disruption for certain materials, Somewhat slower terra production capacity buildup due to the production constellation in Russia, part of which was designated for export. The remaining uncertainty on full device availability and the pace of the ongoing pandemic recovery. We expect our pro form a adjusted operating income margin to be organically 0 to plus 100 basis points higher for the full year.

Speaker 3

As mentioned at full year results, we expect lower gross margin as we invest in new innovation and incur temporarily higher unit and transportation cost for the fast growth of Filoma. Since then, we have observed increased inflation in raw material and energy prices and additional supply chain cost due to war related disruption, including a temporary increase in air freight for both HTU and select cigarette product. Higher expected device sales from the tremendous uptake of IQOSILUMA and easing of device supply constraints also have an initial dilutive margin impact. Despite these added headwind and the further expected COGS increase of around $300,000,000 Compared to our initial expectation, we remain confident that we will achieve organic pro form a margin expansion As our strong revenue growth, favorable product mix and cost saving initiatives deliver sustainable accretion. We forecast pro form a currency neutral adjusted diluted EPS growth of plus 9% to plus 11%, also above our prior total PMI full year guidance.

Speaker 3

This translates into a pro form a adjusted diluted EPS range of $5.35 to $5.46 including an estimated unfavorable currency impact of around $0.63 at prevailing rates. This compared to our previous 2022 Adjusted diluted EPS guidance of $6.12 to $6.30 provided in February with the difference primarily reflecting the exclusion of Russia and Ukraine and an incremental unfavorable currency impact. The underlying ALCO's growth outlook remains excellent. On a pro form a basis, we expect to deliver between 88,000,000,000 92,000,000,000 HTU shipment volumes, representing plus 20% to plus 25% growth over the pro form a prior year of 73,500,000,000 units. This excludes the nearly 5,000,000,000 unit shipped in Russia and Ukraine in Q1.

Speaker 3

And while we conservatively assume no further such contribution From April 1, this implies a total outlook of 93,000,000,000 to 97,000,000,000 units for the year. We continue to expect pro form a HTU shipment to be modestly ahead of IMS for the year after lagging behind in the 2nd quarter, as I will explain later. As outlined in today's release, there are a number of other assumptions underpinning our outlook. We expect the total industry volume of cigarette and HTUs, excluding Russia, Ukraine, U. S.

Speaker 3

And China, to decline by up to minus 1%. Given our leadership in smoke free product, the structural growth of the category and its growing proportion in our business as well as stabilizing share in combustible, we expect to gain share. We therefore target positive total PMI pro form a shipment volume within the range of flat to plus 1%. We assume full year combustible pro form a pricing of around plus 3%, now 1st impact from hyperinflationary accounting in Turkey. The pricing environment is improving, including Indonesia, All the challenges remain due to ongoing pandemic related impact and disposable income pressures.

Speaker 3

Our other assumptions include around $10,000,000,000 in operating cash flow and an effective tax rate of 21% to 22%. We continue to expect full year capital expenditure of around $1,000,000,000 Despite the impact of the war in Ukraine, Our balance sheet remains strong, and we remain steadfastly committed to returning cash to shareholders through dividend and opportunistic share repurchases. With regard to the phasing of pro form a performance this year, we expect a robust H1 overall With margin expansion and adjusted diluted EPS growth weighted to the second half. In large part, this reflects the reacceleration of IQOS As device supply constraints ease, with a sharp recovery in device volume as we replenish channel inventory for user acquisition and we supply the accelerated Illumina replacement cycle in Japan. In addition, our average device than the prior year, reflecting step up commercial activity to drive acquisition, including the broadening of our device portfolio with Lille and the LumaOne.

Speaker 3

While our devices continue to be priced at a meaningful premium to heavily discounted competitive offering, We have already seen encouraging signs in stabilizing our high category share. Moreover, As we adjust our supply chain flows to prevailing global disruption in various material and logistics services, Combined with the effect of the war in Ukraine, there may be a risk of short out of stock situation on certain cigarette SKUs in select market, And we are making adjustments to some product to reflect the availability of specific material. The reorganization of supply chain flows will contribute to the later timing of shipment to certain markets. We notably expect Q2 to be impacted by a number of temporary or specific factors, including the reversal of certain Q1 timing benefit. Organic pro form a net revenue growth is expected to be low single digit with other notable factors, including the delayed timing of HTU and cigarette shipment to Japan with an approximate 2 point drag on growth and a further impact from the shift to hyperinflationary accounting in Turkey, where the cutericks and rate comparison is accentuated.

Speaker 3

We expect total PMI pro form a HTU shipment of around EUR 20,000,000,000 in Q2, partly reflecting around EUR 3,000,000,000 less HTU shipment to Japan than originally planned. This compared to EUR 18,700,000,000 pro form a in Q2 2021. We expect this EUR 3,000,000,000 unit to move to H2, generating a further growth acceleration in the 3rd and 4th quarters. For Q2 pro form a operating margin, the Current senior flow growth of 5% to 7% compared to $2.86 in the prior year. In combination with our strong Q1, H1 pro form a top line performance is expected to deliver organic growth of 5 In H2, the powerful drivers of pricing, scale and efficiencies and the receding of temporary cost headwinds should outweigh inflationary pressures to deliver strong top line growth, Organic margin expansion and an acceleration in bottom line growth.

Speaker 3

Our strong 2022 outlook places us firmly on track Deliver our 2021, 2023 CAGR targets on a pro form a basis of more than 5% in organic net revenue growth and more than 9% in currency neutral adjusted EPS growth. Percent of the $2,100,000,000 of Q1 RRP pro form a net revenue, reflecting higher year over year device volume as supply constraint eased and Filuma performed strongly. We delivered organic growth of +10 percent in Q1 pro form a net revenue and shipment volume growth of +4.9 percent. This growth reflects the twin engine driving our top line. The first is pricing, led by combustible.

Speaker 3

The second is increasing mix of reduced risk products in our business at higher net revenue per unit, which continue to deliver substantial growth, an increasingly powerful driver as our transformation accelerates. Let's now turn to the driver of our Q1 Our pro form a gross margin decreased organically by 2 50 basis points, reflecting the factors I mentioned earlier. Conversely, our pro form a adjusted marketing, Administration and reserve costs were 210 basis points better organically due to the positive operating leverage of IQOS growth and successful cost efficiency programs. We generated around $180,000,000 Our gross cost saving in the Q1 with around $80,000,000 in cost productivities and $100,000,000 from SG and A. This makes over $1,000,000,000 since the start of 2021, already over halfway towards our target of around $2,000,000,000 for 20 20 onetwenty 23.

Speaker 3

This allows us to invest in top line growth and mitigate inflationary pressures while continuing to deliver solid margin progression. We continue to accelerate investment in our commercial programs, digital engine and R and D as well as a number of growth opportunities across category and geographies. As reflected in our full year guidance, we expect our operating margin progression to improve over the course of the year as Our combustible portfolio performed well in Q1 with robust pro form a growth in volume and organic net revenues. This notably reflects a further recovery in Indonesia and the Philippines, supporting an expectation of organic net revenue growth and broadly stable volume in our South and Southeast Asia region this year. Increased travel also supported volume growth in Spain and duty free.

Speaker 3

Our share of the combustible category continued to recover with 0.4 point pro form a gain in Q1 on a year over year basis. This includes gain in Japan, Turkey and Duty Free as our portfolio initiatives bear fruit and social consumption resume with Marlboro share plus 0.3 points higher. While the category is declining over time, our leadership in combustibles To maximize switching to smoke free product and we continue to target a stable category share over time despite the impact of IQOS cannibalization. In terms of our overall market share now, ongoing gains for our IQOS portfolio create Continued positive momentum. We delivered pro form a share growth in Q1 as expected, including gains in Italy, Beauty Free, Egypt, Germany and Poland.

Speaker 3

PMI HTUs are now the 2nd largest nicotine Brand is the market where they are present with a 7.5% excluding Russia and Ukraine. This includes the number one position in 6 markets. Moving now to the IQOS performance. We estimate there were approximately 17,900,000 IQOS users As of March 31, excluding Russia and Ukraine, which had an estimated 4,800,000 users at December 31, 2021. This reflects pro form a growth of more than 1,000,000 users, a phenomenal performance by historic standards.

Speaker 3

This was driven by the resumption of consumer program in many markets as on the strong underlying demand for the brand as also evident in the very impressive start of IQOSILUMA. We estimate that 71% of total IQOS users outside Russia and Ukraine or 12,700,000 adult smokers have switched to IQOS and stopped smoking with the balance in various stages of conversion. We were also very Encouraged by the FDA's recent MRTP order for IQOS 3 with a full range of authorized IQOS products now classified as modified risk In the EU region, 1st quarter HTU share reached 7 point 6% of total cigarette and HTU industry volume, representing a 1st quarter share gain of 2 points, including a small benefit from the timing of inventory movement. Adjusted IMS volume also continued to exhibit Robust sequential growth, and we expect this to continue in the Q2, noting that the usual seasonality of the convertible market, combined with the reversal of Q1 inventory movement, is expected to result in a lower sequential share in Q2. This very good performance include strong user and volume growth across the region with especially notable contribution from I also want to again highlight Hungary and Lithuania, where our Q1 national HTU share exceeded 25%.

Speaker 3

To give some further color on our progress in the EU region, this slide shows the selection of the latest key city of Techshares. While business continued to lead the way approaching 40% share, Budapest, Rome and Athens are also well into the mid to high 20s. Elsewhere, we are especially pleased by Vienna more than doubling to 5%, The strong traction in London at over 6% share and a further acceleration in Zurich with the introduction of Illumina. In Japan, the adjusted share for our HD brands increased by +1.9. To a record 22.7% in Q1.

Speaker 3

This performance reflects the strength of our portfolio and the launch of IQOS Illumina, which is also driving notable gains in Tokyo and other key cities. We expect strong offtake trends to continue in Q2, reaching around 24% market share despite seasonality effect. Conversely, as I touched on earlier, Supply chain constraint will likely result in Q2 HTU shipment below the prior year. With HTU inventory consequently reduced in the We expect the replenishment in H2 to deliver a substantial recovery. Notwithstanding such quarterly volatility, with substantial commercial activity plan and excellent underlying momentum, We expect strong double digit HDU shipment volume growth in Japan this year.

Speaker 3

In addition to strong progress in developed countries, we see very promising IQOS growth in low and middle income market. The share of our HD brands in the 28 such markets launched by December 31, 2021, excluding Russia and Ukraine, grew by plus 0.8 points compared to the prior year to reach 2.7%. Given the large size of this market, the premium positioning of the exiting IQOS portfolio and the relatively early stage of commercialization, This represents excellent progress. As mentioned last quarter, we also intend to bring a new complementary range of heat not burn devices and HDU's tailored to emerging markets towards the end of this year. A prime example of this is Egypt, where Oftech exit share in Cairo is approaching 5% within 8 months of launch as compared to total Q1 share of 4.3%.

Speaker 3

Other notable successes, including the recently launched market of Morocco as well as Lebanon, Jordan, the Dominican Republic and the Philippines despite pandemic restrictions in Manila. Moving now to IQOSILUMA. We are delighted to report the further outstanding success since its launch with sales performance and consumer reaction still exceeding our expectation. In Japan, the uptake of Illumad Devices and Consumables among both existing IQOS user and legal edge smoker has been rapid With more than 30% of the large user base up trading since the August 2021 launch and over 20% of sales We remain to legal edge smokers new to IQOS. Moreover, the enhanced and consistently high quality User experience, better reliability and no need for cleaning has led to significant observed increases in conversion rates, retention rates and net promoter score.

Speaker 3

This bodes well for volumes with premium priced Terra consumable, the fastest Growing launch in the smoke free category, reaching an offtake share of 12% within 6 months of national launch, Overtaking Marlboro Hipstick and Itz combined to become the number one smoke free brand. We now have all 3 IQOS Illumad Devices in the market following the launch of ILUMABY-one, which provides multiple consecutive use at a more affordable price point. We are also introducing a new HTU brand called Sentia for use with Illumina in select prefectures at the mainline price point comparable to Eats. Results in Switzerland have again been even more remarkable with significant sales to new user and Terria making up almost 2 thirds of HTU sales after only 5 months of commercialization. Our HTU share growth has from less than 6% in Q3 to 9% this quarter with notable success in the German speaking majority of the country.

Speaker 3

Our newest Illumina launch was in Spain last month. While very early days, the signs are also very positive With device sales to new user increasing plus 50% compared to the prior run rate, 10% of existing user upgraded within the 1st month Antheria exiting March at over 1 quarter of total HTU of tech. These results across 3 markets with different consumer characteristics and level of RRP maturity are clearly very encouraging for the wider rollout of Filmer Around the world. While device supply constraints are easing, the timing of HTU availability for new alumina market Has been somewhat delayed given the rapid uptake in the initial market and the resulting need for greater supply for each new market than was originally anticipated. In addition, the constellation of our investment in the production of Perria HTUs in our Russian facility has a short term impact.

Speaker 3

As a result, further market launches are now mostly expected towards the end of H2. With Illumina, IQOS 3 Duo and Bill, We now have 3 Idnotburn technology under the IQOS umbrella to serve different consumer needs and segment the market. We have an exciting pipeline of innovation on devices and consumables at different price tiers. In I Vapor, IQOS VIZ's promising results in the 1st group of market continue. VIZ is a premium proposition with an average price premium to competitive device of 20% to 30%, making these results especially encouraging as we pursue a differentiated and profitable category leadership position over time.

Speaker 3

We see further success in Italy, reaching almost 20 percent of Teck's share of closed system pods with rapid progress also visible in Croatia within 8 months of launch. In the Czech Republic, after some temporary supply disruption at the start of the quarter, which affected Q1 share, Rapid growth has resumed. Vive was present in 7 markets at March 31, and we plan to add more this year with time subject to device availability. Separately, our relaunch conversation of nicotine pouches under the Shero brand in the Nordic is progressing well with positive consumer feedback. Moving to sustainability and our ESG priorities.

Speaker 3

I'm happy to share 2 important developments published in our 2022 proxy statement. Firstly, our Board of Directors updated our company statement Expanding it beyond smoke free to better reflect the role of wellness and healthcare in our corporate strategy and transformation. 2nd, the introduction of a bespoke sustainability index explicitly links our ELG performance to 30% of long term compensation. Further details will be shared in our integrated report on May 17 and further dedicated disclosures. Product sales impact remain one of our most critical ESG priorities And the growing penetration of smoke free products around the world is accelerating the end of cigarette as legal aid smokers switch to better alternatives.

Speaker 3

There is a growing body of scientific and real world evidence of the substantial risk reduction potential of smoke free product compared with smoking. While challenges in some markets are to be expected, we continue to support regulatory and fiscal framework that recognize the positive impact Tobacco harm reduction policy can have on public health. A recent example of this is Italy, which has established distant excise tax category for heat not burn, heat not burn, e vapor and nicotine pouches. Thank you. And I will now turn it back to Jacek.

Speaker 2

Thank you, Emmanuel. Despite the challenges in Russia and Ukraine, We have delivered an excellent start to the year with a strong recovery in IQOS user growth and exceptional initial results As we covered recently at CAGNY, we have a rich pipeline of feather smoke free innovations to expand and grow across new and existing categories and geographies. Our combustible business is now stabilizing category share Despite the impact of IQOS cannibalization, which allows us to accelerate further switching of smokers to better alternatives. We also continue to invest for long term growth for the development of innovative wellness and health care products, We seek to deliver a net positive impact on society. Our 2022 fundamentals are strong With a pro form a expectation of 4.5 percent to 6.5 percent organic net revenue growth and 9% to 11% Currency neutral adjusted diluted EPS growth.

Speaker 2

Despite the significant inflationary pressures and disruptions in the global Supply chain affecting first half and the full year, we also expect our organic operating income margin to expand to up by 100 basis points. In addition, we have taken the conservative assumption in our reported guidance of no further contribution from Russia or Ukraine from April 1. Overall, We are very confident in the near and mid term growth outlook and remain committed to sustainably rewarding shareholders over time as we continue our transformation. Thank you, and we are now happy to answer your questions.

Operator

Thank you. We will now conduct the question and answer session.

Speaker 1

Operator, this is Nick Rollie. Can I just interrupt for one second? I understand we had some technical With the webcast, and I apologize for that. The full script and slides are posted on our website. So please access www.pmi.com And we will correct the replay on the webcast following today's presentation.

Speaker 1

So you can go back to the website and if you missed any of the audio sound, but

Speaker 2

you can get the

Speaker 1

Thank you.

Operator

We will now conduct the question and answer portion of the conference. Our first question comes from Chris Growe with Stifel. Your line is now open.

Speaker 2

Hi, good morning. Good morning. Hi, Chris.

Speaker 4

Hi. I just wanted to ask if I could first, as I think about your IQOS guidance for the year and obviously reducing that for Russia and Ukraine. I just wanted to be sure as you think about As those that new guidance incorporates your expectations excluding Russia and Ukraine, is that the only adjustment you've made For volume in that estimate, the new $88,000,000,000 to $92,000,000,000 is that just taking out your expectation for Russia and Ukraine for this year?

Speaker 2

That's correct. We're just talking for the entire year the volumes from Russia and Ukraine. But then obviously, for the Q1, we recognize what have been sold in above geographies, which is the 5,000,000,000 Therefore, on a pro form a for the full year, excluding Russia and Ukraine, we're looking into 88% to 92%. But if you add back the 5%, Which will result during the 1st period, the Q1, I mean, that technically translates to 93%, 90 7, which would assume or is assuming that there was no further sales of IQOS as of April 1 in neither Russia nor the UK.

Speaker 4

Got it. Thank you. And then I just want to understand a little bit about the second quarter. You've talked about higher device shipments in the quarter, I think that will be a stronger driver of revenue growth. At the same time, you have some timing differences.

Speaker 4

It sounds like at least in Japan, where that will weigh on revenue overall. I think you're expecting more like a low single digit increase in revenue. So I just want to understand, I guess, To the degree you can help in terms of the magnitude of those two factors, it sounds like the Japan timing may be a larger factor on 2Q revenue. Then just to understand also the availability of devices. Is it the second half when that's back to like a, I'll call it, full availability of devices?

Speaker 4

And is that a function of not having devices committed to Russia and Ukraine is providing more availability for the rest of the world? I hope that's clear. Thanks.

Speaker 2

Yes. Okay. So the Q1 shipments of the devices, on the one hand, yes, you absolutely rightfully contribute to the better revenue, But remember that the devices are putting a pressure on the margins, right? So that's the story between the device And the impact on the one hand on the revenue than the margins. The big impact which we expect to have in Q2 is on the Supply of the shipments of the consumables, like the heat sticks and the terrier.

Speaker 2

And as a result, among other constraints on the On the supply chain, over stopping the investment in Russia, we need to resource that missing capacity to other locations, and It will take us a while, and therefore, we expect that we will go lower of the with the inventories in Japan, mainly Japan, In order to ensure on the manufacturing side the proper resourcing, we will have when we expect quite a robust Growth on IMS and the market share, and I think Emmanuel on the slide have indicated that we should think that we're aiming at the 24% around 24% the market share for the quarter in Japan. So it's nothing on the consumer level or on the off day level, But we need to do these operations through the inventories in order to resume to the normal course of the shipments in the Q3 and Q4. And hence, this will drive the better performance or stronger performance in the second half than the first half, Which will be what we estimate to be impacted by the Q2 difference in the shipments. Now with regards to the devices, I mean, we there is this continuous sale of the devices in the excluded geographies, right?

Speaker 2

So it's not that we Stop selling. We stopped recognizing this whole thing due to the visibility and other factors, What is happening in Russia and Ukraine, but in reality, we need to keep at least the replacement devices, Right. So it's not that you can take the volume out of Russia and Ukraine and We'll redirect them to other locations. We do have actually getting a better and better, But not perfect visibility with regards to the device supplies. And remember, we've been very cautious about this as of second half of last year.

Speaker 2

And the moment when we had the better order fulfillment and also better visibility with regards to the future orders For this year, we feel more confident about how we can realize the fully realize the opportunity of IQOS. So that looks okay. It's not perfect, but I don't want to mislead anybody. It's not perfect, but it's better than, At the beginning of the year. And you saw it at the moment that we regain somehow almost full fledged availability of devices, How IQOS could accelerate its growth for the user acquisition and the market share progressions in Q1.

Speaker 2

So We know that we have it, but everything hinges on the continuity and undisturbed, uninterrupted supplies of devices and heat sticks.

Speaker 3

And Chris, maybe just to compliment, I think it's really important that everybody understand the evolution of the gross margin in Q1, Q2 and H1 versus H2. I'm sure you remember that last year, the gross margin in H1 was extremely high. We were at 70%. The gross margin was lower and probably more normative in H2. So what we have seen in Q1 was, 1st of all, facing very high comps.

Speaker 3

I think we've been Describing in the presentation the various driver for the 2 50 basis point reduction in the gross margin, What you can expect for Q2 is this element to continue knowing that the gross margin reference is 70% as well last year in Q2. And on top of it, we will have more devices even than in Q1, which I think is good news because it shows the success of IQOS. We have increased air freight costs for the reason that we mentioned and the tension on the supply chain, And that's going to have an impact on the margin. And last element, you have this mix, which is a temporary element, of course, Like Alfred, by the way, on the fact that the volume will be lower for Japan in Q2 with the recovery and the compensation in H2. And with that, you have the reason for increased pressure, gross margin pressure in Q2, but with the compensation that will come in H2.

Speaker 4

It was great color. Thanks so much.

Operator

We will take our next Question from Pamela Kaufman with Morgan Stanley. Your line is now open.

Speaker 5

Hi, good morning.

Speaker 6

Good morning, Joanna.

Operator

I have

Speaker 5

a question on the 2023 outlook and how you're thinking about your targets for next year, Particularly on the HTU side, should we assume a similar reduction to your heated tobacco targets as the guidance reduction for this year of about 20%. And given Russia's significant contribution To the overall IQOS business, how are you adjusting your strategy for achieving your target for 50% of revenue coming from Smoke Free Products by 2025. Thank you.

Speaker 2

Well, we continue with the geographical and the portfolio Expansion of IQOS in the existing and the new geographies. And obviously, this we're confronted with all the Supply chain constraints and availability of devices, etcetera. So I mean, we all know this. The good way of one of the way maybe To look at the 23 targets, I believe you referred to the absolute volume target for IQOS is that, Okay. Let's assume that we don't have the lowest assumptions you can make is that we will not realize any further sales as of April 1 in the Of Russia and Ukraine, and that's essentially the floor of that thing.

Speaker 2

Where do we land? I think everyone will appreciate we need a little bit of a time to really have the full visibility what we will do with our business and our intentions about There will be a band in absolute numbers. There's no questions about it. The way I log into this whole thing, we may be in situations that will Deliver the targets, but with about a 12 month delay. I mean, I am not in a position my thinking is not change the target.

Speaker 2

Just recognize that you maybe need a little bit of additional time to deliver on this target. All other parameters, the relative growth targets Being the top line, bottom line and the relative growth of the relative contribution, And on that one, I'm confident we should be in a position to deliver this one. But in absolute volume, yes, I mean, we might have a Miss, by the way, again, sorry for repetition, I look at this, maybe I need a 12 months more to deliver the same target for other geographies and organic growth in existing geographies.

Speaker 3

And Pamela, on your question on how do we get to more than 50% in 2025, I'm sure you've seen that in Q1 on a pro form a basis, Excluding Russia and Ukraine, we're a bit below the full perimeter of the group, but not that much below. So we are 30% versus around 31%. So yes, there is a bit more ground to cover to get to 50%. But given the dynamism that we see in our IQOS business and the opportunity We've been clearly showing in low and middle income country. We think we can Catch up and deliver this more than 50%.

Speaker 3

Thanks.

Speaker 5

And then a question on new IQOS user acquisition. You saw a good recovery this quarter despite taking out the impacts from Russia to over 1,000,000 users. Do you expect to see a similar pace of new user acquisition over the course of the year? And how much of a role did Ooma play in that?

Operator

Please stand by. We are having technical difficulties.

Speaker 5

Hello?

Operator

And we do have that backup line connected now.

Speaker 5

Did you hear my question?

Speaker 2

Yes. I think your question was sorry, because we all cut off the sentence. Your question was, we can expect the same dynamics of the user acquisition, right, going forward? Yes. Okay.

Speaker 2

So look, I mean, the million or about 1,000,000 acquisition this quarter, which show where they go sequentially above Close to the million acquisition in the Q4, I mean, that's directly correlated to our availability of the To the availability of devices and a full portfolio of devices, as you know, we also play now the different price segments games. We have more I actually think that number should we should repeat the same sort of the rate, if not actually higher, because You could see from the conversion perspective and the consumer liking measured by NPS and other parameters What we're offering today really is meeting the consumer expectations. So This is also bridging somehow to the default question that once we see the visibility on the devices, right, in the next Quarter or so and all the dynamics which we can achieve outside the Russia and Ukraine, then we would be in a position to revise What actually will it deliver in a year from now in terms of a total IQOS volume.

Speaker 5

Thank you.

Speaker 2

Thank you.

Operator

We will take our next question from Vivien Azer with Cowen. Your line is open.

Speaker 7

Hi, good morning.

Speaker 2

Hi, good morning, Julia.

Operator

So I

Speaker 7

wanted to follow-up on Japan. I'm just having a hard time reconciling, 2 comments that you guys made. Number 1, that there was negative device mix in the quarter, but that you had device growth from Aluma because last quarter I thought the launch of Aluma was mix accretive in So am I misunderstanding something or did something change? Thanks.

Speaker 2

I I think that device mix, we're talking that we're selling a free as of now free versions of IQOSILUMA. You have a premium meat and the lower price. Lower price was just introduced now to the market, to the consumers. So obviously, in the shipments, we already had them in the Q1, right, because this is all recognized on the shipment. And second is that these devices, I mean, the Luma 1, Which is the lowest price device, goes at attractive price in a market higher than the competition's, but Even lower than the price that we used to have on the one version of IQOS 3 before.

Speaker 2

So maybe here to Vivien when you need to look into.

Speaker 3

Yes. Vivien, if I may, Emmanuel speaking. It's a positive in the mix within the device because it's come at a higher price. But any growth in device is negative to the mix in terms of gross margin because it's coming with, of course, a much reduced gross margin versus The consumables. So the more device we sell, you have some impact on the revenue, which is positive, But it has a dilutive impact on the gross margin rate, to be very clear.

Speaker 7

Understood. I think what I had Sales to Grass was the pricing tier. So thank you both for that. For my second question, I was hoping to get some incremental color on Germany. You had meaningful share growth both on a year over year and a sequential basis.

Speaker 7

Is there anything to call out there from an activation standpoint? Because the results were very strong.

Speaker 2

No. This again comes to a post price increase post price change environment in Germany. That's the one thing. And second is, again, I mean, the German starts benefiting from not restricted access to the devices. This again follows the same story that if we have a continuous broad range availability of the devices, we can go into the portfolio again and And the performance, and this is one extra one additional comment I would make here, Vivien, is that Germany is still running on the IQOS 3.1 version, which is a blade version.

Speaker 2

And The reasons why we went, for example, to Switzerland with IQOSI LUMOZA is before opening the larger market, which obviously will Take a lot of volume of the devices, how IQOS Illumables to perform in the similar sort of a geography. So I'm very pleased with the success so far of IQOSILOMA in Switzerland and especially the German speaking part because I used it as the We could use this as the proxy for German on acceleration of the further acceleration of the growth in German. Now Nothing is settled in live, but I think this is as far as we can read through the consumer reactions in Switzerland.

Speaker 7

Understood. Thank you very much.

Operator

We will take our next question from Bonnie Herzog with Goldman Sachs, your line is now open.

Speaker 8

All right. Thank you. Hi, everyone.

Operator

Hi, Bonnie. I had a

Speaker 8

Few questions on Russia. I guess I was hoping you could share maybe just a few more details on your exit from the country and really what the mechanics of that are. I guess, could you help us understand what's being manufactured in the market currently? And What about the volume your manufacturing facility in St. Petersburg exports?

Speaker 8

Can you Share with us roughly what percentage of the volume is exported and then where you plan to maybe shift that volume to and when? And I guess I'm just trying to think about all this in terms of any costs associated with that and then is that being reflected in your guidance?

Speaker 2

So, Vangi, it's Diasak here. Judging just by the number of details you mentioned in that question, You will appreciate how complex the situation is in Russia. So 1 by 1, Russia in terms of the So far, production and export allocation was not really that significant. We had a much more significant plans of Spending Russia is one of the key suppliers of new IQOSILUMA and hence our decisions to Immediately stopped the investment as a result that we created a temporary hold for the rest of the market, partially For Russia launch of Vilumab, which we also canceled, but also that Russia was supposed to contribute to the supply of the The Lumark consumables tariff statistics into other markets, including in Japan. So our first priority is how do we can So that capacity there.

Speaker 2

Obviously, that capacity means that we have an equipment installed in Russia, And we can't we don't use this equipment today. What will happen to that equipment going forward, we're also working on a certain plan, But I would stop here. I will not go into more details. Now the exit Russia in the orderly manner For us, it means that we need to reconcile the interest, first of all, of our shareholders, The employees in Russia and you know that the ever evolving legislations in Russia puts the significant Risk or constraint of our ability to add growth and this is all in the context of a very Evolving regulatory environment both of the international, it's obviously the sanctions, but also the legislations Legislation in Russia. So if we want to know, we have a significant presence in Russia As we all know it, we're in the market organically build this business over the last 30 years.

Speaker 2

This is 100% business of PMI National, we don't have any partners contributing to the coal business. We obviously are connected with the local supply chains and Wholesale and distribution components, but PMI Zora and Philip Morris sales and distribution is 100% Philip Morris business. We have some shareholding in addition to this with a key distributor in the market. It's together along with our Major tobacco companies and to unwind in order loops manner all the strengths which we have in Russia It's a complex endeavor, but we are committed to do so. Hence, Our guidance and the decisions to look at the PMI is the rest of the business, which is Doing absolutely great despite all of the headwinds which we have and so on, Rather than pollute it with something which we have limited visibility and ability to act accordingly.

Speaker 2

So I know that my answer had not gave you both clarity, but that is the best which we can Sorry at this moment. I mean, we're working on the exit, but it's presumably one of the most complicated Transactions in front of the history of the group, which we're having from the

Speaker 8

And just to be clear, just in terms of the exit, do you have a target date, the full exit

Operator

of the market that you can share?

Speaker 2

Well, we'd rather not delay beyond what is necessary as long as we satisfy the older Team, Quest Groups and the like. And again, I repeated, I mean, our we have a responsibility to shareholders, but we also responsibility to employees in Russia and overall Broad group of stakeholders with the various expectations, okay, and you try to resolve that equation to the Satisfaction of everyone has becoming a complex exercise. But we're working relentlessly of how to Move forward. I mean, I would appreciate that if there was any other size of the business and presence in the market, things could have looked differently, But this was a very big business for us.

Speaker 8

And honestly, that kind of brings me to my second question. As I think about your new Pro form a HTU volume guidance of $88,000,000,000 to $92,000,000,000 units for this year, which is assuming 22% growth at the midpoint. I guess I'd like to understand the key drivers of that since the growth outlook is now, I guess, above your previous guidance. But Russia really, I thought was such an important driver of that and for your future. So I just kind of want to understand what gives you The confidence, especially also on top of the uncertainty related to the semiconductor chip shortage situation.

Speaker 2

Thanks. Yes. So, thank you. So, obviously, you need to make some or making some assumptions on the supply chain. As I said earlier, We don't live today in a perfect visibility for all the remaining quarters of this year, but I think we have enough of the confidence to Come up with this pro form a to estimate of this pro form a guidance.

Speaker 2

Now Look, you see the continuous trajectory of IQOS growth in essentially all geographies, including the geographies that historically will have been Tougher for us, where we had the progress, but they were not really going at the group level of the growth. And now we see that Japan with Illumina and few other locations with Illumina already having a massive acceleration of the growth. We know what we have in our plans for this and thereafter with Illumina. We also know that IQOS 3.1, 3.0, Which is, you know, that's the currency, the most result device also continues to be very attractive. And this is continuously despite the fact that we Offering our portfolio both of the devices and the consumables at a significant premium to any other market Propositions.

Speaker 2

I think we're getting this confidence that IQOS can continue to grow, and we're looking forward also to the moment when it will Accelerate its growth. We like those in the near term excluding Russia and Ukraine, sorry, the rest of the geographies Compensate the lack of Russia on Ukraine. I think over longer period of time, we won't notice this. In a shorter period of time, it might be Challenging, okay. So we're not making any promises at this stage.

Speaker 8

Okay. Thank you.

Speaker 2

Thank you.

Operator

We will take our next question from Garbun Jain with Barclays. Your line is open.

Speaker 2

Good morning, Mr. Manuel and Asik. So I have a couple of questions.

Speaker 1

We cannot really hear you. Could you repeat the question, please?

Speaker 9

Sure. Is this better?

Speaker 1

Yes, better. Yes, better. Yes, thank you.

Speaker 9

Sorry about that. So my first question is, your guidance

Speaker 1

on industry volume and your own volume ex Russia and Ukraine,

Speaker 9

so it seems Volume and your own volume ex Russia and Ukraine, so it seems to have become better. And if I look especially at your European volumes, they are quite strong. So we have the sort of the macro pressure on consumers and inflationary pressure and Europe might be in recession, not in recession, oil price impact. So my question is that why are you seeing stronger volumes? And is it that When cigarette prices historically used to be up 4% in Europe and wage growth was 1%, so cigarettes were becoming less affordable.

Speaker 9

And right now cigarette pricing is still 4, while wage inflation is probably 4 or 5. So cigarettes are actually becoming more affordable And that's why you are seeing better volume trends.

Speaker 3

Well, I think we should I mean, we have the information of In the coming quarters, I suppose there is some trend in the market that are Underlying trends in terms of demographics and behaviors, let's face it, there is also still the continuation of rebound after the COVID. So last year was not a normal year. We are becoming much more normal. I'm not saying we're there yet. And clearly in Duty Free, we're not.

Speaker 3

But in other markets, we can hope that for the coming months to be more normal, and that's going to be a positive. So I don't know what's going to be the impact of a potential Slowdown of the economy, is it, by the way, going to have an impact on volume or more on down trading and some countries in consumer Going for cheaper offering, today what we see and is in highlighting that is Mabo recovering market share. We see Chesterfield being very successful and we see, of course, great success with all our IQOS brands. So that is what is driving for us This outlook for growth in volume and of course, starting Q1 with a very nice growth, Even if we flag the fact that there was some maybe some anticipation, but I think that the Q1 numbers are there, it shows the dynamism that we are seeing in our portfolio. Sure.

Speaker 9

And coming to the EPS guidance and the dividend, so your dividend payout ratio will now be north of 90%. So how does that impact how you're thinking about share repurchases? And we keep seeing these cycles with Every 3 years, you have massive adverse FX and we go back 10 years, euro used to be 1.50 yen was 70 Then we had one cycle in 2014 and 2017. Now we have another cycle of FX. And clearly a lot of your costs are in Swiss So is there something you can do so that the cost mismatch, the transaction FX mismatch is lesser?

Speaker 9

And we again get into the situation where dividend payout ratio is becoming very tight.

Speaker 3

Well, Gaurav, so yes, of course, on the basis of the guidance that we've been giving, we would have a payout ratio that would Significantly increased versus 2021. I think we've shown in the past the capacity to Grow more profit over time and reduce that. Our objective is to go down over time and we did not give any kind of Precisely to go down to 75% is still there. I agree that given the adverse event that we are facing, it's going to take a bit more time to get there. Les Bikay is not so much I mean, the currency is playing, but it's really the culmination of currency and Russia leaving the perimeter of the group that is Driving that situation.

Speaker 3

Now on the ForEx, there is 2 elements. 1 is the pressure on margin, And we continue to work on trying to equalize better the currency in which we're invoicing and the currency in which we have our cost. We do that through the supply chain. There are some limitation because

Speaker 2

there are a number of

Speaker 3

things that you buy in dollar, but of course, we do that through Everything we buy, but there is one element that we cannot change that we have limited invoicing in dollar. So when the dollar is Going up versus most of the currency, that is an impact which is mechanical and on which there is not much we can do. So We can work and I think we continue to work on the margin dimension. We cannot work on the fact that we have limited invoicing in dollar.

Speaker 9

Sure. Thanks a lot.

Speaker 2

Thank you.

Operator

We'll take our next question from Owen Bennett with Jefferies. Your line is now open.

Speaker 1

Owen, do you have a question?

Operator

It appears Mr. Bennett has dropped. We will go ahead and take our next question from Jarrod Binks with JPMorgan. Your line is open.

Speaker 6

Hi, guys. I just wanted to ask about the Hi, guys. Hi, guys. I just wanted to ask about the pricing environment given inflation in places like Europe is it's reaching levels Not seen for a long time, do you think there could be more of an opportunity to put through additional price increases given You are seeing cost inflation as well on a global basis, especially post Russia and Ukraine. Maybe we can see a bit more of a margin offset?

Speaker 2

We're taking price increase and price variance. The opening of the year can be better than we initially talked. I will see what the remaining part of the year, especially the second half will bring. When we look at the inflation, I mean, we also have to Look what is the inflation of the material, so or you like the cost of living and what is the inflation of the income, Right, because we haven't yet seen the inflation on the income level at the constant level. So we have to Find the right spot and the right balance, where do we get into this.

Speaker 2

But in most of the geographies, I mean, at the pricing environment, I would characterize it is getting positive. I mean, Emmanuel talked about the Indonesia. On the other hand, we have a very Strong rebound in the volumes in Indonesia and hopefully also Indonesia, which used to be Quite important or significant contributor to the pricing. Hopefully, Towards the end of this year, definitely 23 will resume its pricing contribution. We had a price increase in German flowing through the market.

Speaker 2

It was the Philippines, but Turkey, okay, now Turkey goes to the hyperinflationary accounting, but we're trying to price it wisely, Looking at the inflation, here is the pressure. But as I said, at the beginning of the year, we already started with the head of our loan

Speaker 6

Got it. And maybe just to follow-up on Southeast Asia. Clearly, it's a very strong start to the year in terms of volumes. What are your expectations there on the volume side for the rest of the year?

Speaker 2

Well, there is this continuous Remember, this is the part of the world, which is still not out of the woods with regards to COVID, unfortunately, right? So the situation not really I didn't get back to the pre COVID guidance. I believe there is some underlying growth opportunities just by the fact that As they continue to recover from the COVID situation, we should start seeing the continuously better volume. And as I said, I mean, we took the price increase in Philippines. We're taking some pricing.

Speaker 2

Taking the pricing a little bit accelerated in Indonesia, but on the other hand, we're still in the as you remember, Indonesia takes a couple of rounds of That's of a price increase to pass on the beginning of the excise increase. So we still need a bit of a time in order to go in

Speaker 3

And Jair, as we said, We expect to grow nicely revenue in the region this year, which would be a very nice evolution.

Speaker 6

That's correct. Thanks guys.

Speaker 2

Thank you.

Speaker 1

Thank you. That was the last question, operator.

Operator

And there are no further questions on the line. I will turn the program back over to Nick Rollie for any additional or closing remarks.

Speaker 1

I think Jacek has some closing remarks.

Speaker 2

Okay. So thank you, Varun, for your attention and the patience. And quarter was pretty complex and complicated for us. And since there, due to some technical problems, the earnings I have one on the comment Once everyone, I hope he's still on the line. I would like to take this opportunity to thank Mr.

Speaker 2

Nigroly's Our outstanding contribution to PMI and our former parent company over the past 35 years, And particular as the Vice President, Investor Relations since the 2008 spin of Filipinos International. As you all, I believe, will agree with me, he has been a critical contributor for the journey of our company. And I know that you, our investors and analysts, will join me in congratulating Nick and to wish him all the best for his Very well deserved retirement. At the same time, I would also like to congratulate James Bushnell On his new role, I have a pleasure because I personally was hiring Mr. Bushnell some years ago To PMI in his new role as the successor to Nigroly, and I believe he will receive the same support and a warm welcome as Nigroly enjoyed for the last 35 years.

Speaker 2

So welcome, James, and thank you, Nick.

Speaker 1

Thank you, Yacic. Thank you, Emmanuel. Congratulations, James,

Speaker 3

Thank you all on the

Speaker 1

call because I know we've had some long relationships with many of you and I value that relationship And that concludes the call. And again, we apologize for the technical difficulties on my last call, But we'll resolve everything and look forward to dealing with your follow-up questions. Thank you very much.

Speaker 3

Talk to you soon, guys. Thank you.

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Earnings Conference Call
Philip Morris International Q1 2022
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