Good day, and welcome to the Philip Morris International Third Quarter 2020 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. [Operator Instructions] Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community. I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Welcome and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2020 third quarter results. You may access the release on www.pmi.com or the PMI Investor Relations app. The 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 heated tobacco unit market data are at the end of today's webcast slides, which are also posted on the website. Unless otherwise stated all references to IQOS are to our IQOS heat-not-burn products. Comparisons presented on a like-for-like basis reflect pro forma 2019 results, which have been adjusted for the deconsolidation of our Canadian subsidiary, Rothmans, Benson & Hedges Inc. effective March 22nd 2019. Please also note that growth rates presented on an organic basis for consolidated financial results reflect currency neutral, underlying results and like-for-like comparison where applicable. 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. Please also note the additional forward-looking and cautionary statements related to COVID-19. It's now my pleasure to introduce Emmanuel Babeau, our Chief Financial Officer. Emmanuel?

Thank you, Nick, and welcome ladies and gentlemen. I hope everyone listening to the call and those close to you are safe and well. Our business delivered an even better than expected performance in the third quarter despite the ongoing circumstances of the pandemic. Most importantly, the excellent momentum of IQOS continues. HTU volumes have grown 28% year-to-date with a positive mix effect on our net revenues, where RRPs again made up almost one-quarter of our business in Q3. IQOS user acquisition outpaced the prior year quarter to reach an estimated total of 16.4 million users at the end of September. While still below pre-pandemic levels in most places, our combustible business recorded an improved sequential performance. Underlying industry volumes were better across both developed and emerging markets, reflecting increased consumption occasions. This was notably the case in market with a significant proportion of daily wage workers like Indonesia, Mexico, and the Philippines. Despite these better industry volumes, Indonesia remains challenging together with Duty Free. We must also retain a degree of caution around a second wave of the pandemic and its overall economic consequences across all of our markets. Our operating margins were again significantly ahead in the quarter and on a year to date basis, despite the challenges in our duty-free business. This reflects the increasing weight and profitability of RRPs and cost efficiencies. Our cash generation was also strong with $3.6 billion of operating cash flow in the quarter putting us on track to reach our target of at least $9 billion this year. Turning to the headline numbers, our Q3 net revenue declined by 1.5% on an organic basis, making -- marking a significant improvement from the decline of almost 10% in Q2. While this was somewhat aided by certain timing factors, including the revaluation of…

Thank you. We will now conduct a question-and-answer portion of the conference. [Operator Instructions] Our first question comes from Adam Spielman of Citi.

Hi. Thank you very much. So, my first question. You've reiterated that you're very, very comfortable with 90 billion to 100 billion target for 2021 for RRPs. Are you still comfortable that you will exceed 250 billion in 2025, which is your other longer-term target? That's my first question. Thank you.

Thanks, Adam. We definitely are repeating our ambition to reach next year 20 -- 200 billion stick in the heat-not-burn category, and I think that the growth that we deliver quarter-after-quarter is clearly pointing to that direction. Then you are alluding to the 2025 objective of 250 billion plus, which is I think here aligned with what I've started to detail on the presentation, which is really the fact that we are broadening the portfolio when it comes to RRPs product, and we are going to of course come with more enrichment, more segmentation, more offering when it comes to heat-not-burn. We are entering the evaping category, and all that is going to put us on the track to deliver that ambition. And I think everything I've been seeing in term of segmentation of the devices now that we are coming with the lil offering, what we have started to do now in Japan, in Russia, when it comes to the consumables, it shows that clearly now the market is getting a bit more mature, of course, it's still at an early stage in most places, but in a few places we have some first element of a bigger market, it is time now to enrich the offering and broaden the spectrum of what we can offer to, I would say, concur and convince more smoker to switch to our product, and therefore that is what is going to put us on the right track for this ambition for 2025.

Excellent. Thank you very much. And then [indiscernible] I don’t want to remind you, I want to put words in your mouth, but your market shares in Russia and Japan, they grew in Q3, but sequentially less than in Q2. And I'm wondering why that was do you think, and whether it really is significant or it's just sort of random quarterly fluctuations and we should just ignore that one?

Yes, I don't think that there is anything to be read there. I think that we are very happy with the performance on the key market. Of course, you know what has been and depending on the season and the consumption pattern and what has been happening on the borders, we know that some borders were closed. We talked about illicit trade being stopped, I mean, that can be disruptors to the evolution if you take a kind of flash or split quarter view. But I would say the trend that we are seeing in Q3, we are very much in line with a nice strong trend that we've been observing over the first part of the year over H1. So, I don't think that there is anything in Q3 that would be signaling a slowdown in the way we are gaining share in an underlying manner.

Thank you. Very clear, very helpful. Thank you.

Our next question comes from the line of Pamela Kaufman of Morgan Stanley.

Hi. Good morning. So, there is obviously a lot of ongoing uncertainty, but as you just reiterated, you are on track for your heated tobacco target for 2021. I guess broadly how are you thinking about how you're positioned for growth next year and do you anticipate accelerating growth as you lapped the performance this year and see benefits from the enforcement of minimum price increases in Indonesia?

Well, thanks for the question. Obviously, it's very early stage to start talking about next year. I think you very rightly said it, 2021 is full of uncertainty and we even recognized that the last months of 2020 has a fair share of uncertainty as well. So, difficult to of course start to elaborate on 2021. The only thing I can say at this stage is that we are going to enter 2021 with the strength of our RRP business that is clear from this first nine months performance. There will be certainly a number of low comps in the basis of 2020, but as we don't know how the markets are going to be in 2021, and if I take the example of duty-free, which of course you could say we're going to have nine months with very, very low business in duty-free in 2020. So, one could argue well that's an easy basis of comparison, but nobody is able to say today what's going to be the rebound next year of duty-free. So, it's just difficult to say which kind of growth trajectory at that stage it designs if you want. I hope we'll know more at the beginning of 2021, when we will comment on our full-year 2020, and at that stage we can share more details with you, but I think that for us, the main element today that I would say is a kind of for sure whatever is the environment, it is a very, very strong performance of our heat-not-burn business.

Thank you. And also obviously very strong margin performance in the quarter. Can you elaborate on the factors that contributed to that in terms of lower marketing and administrative costs? You pointed out manufacturing efficiencies. How are your IQOS customer acquisition costs trending and how much of the lower cost is temporary versus sustainable going forward?

Sure, happy to do that. Well, the margin improvement is and that's probably the strength of the performance is not coming from one element. I think it's a collection of drivers that we have to add to the topline evolution, nice margin evolution. And that is coming first, of course, from the growth of RRPs, and I think we are showing this quarter's impact on the gross margin of the positive impact on the mix of the consumable in heat-not-burn. And as we keep growing the business that is of course a nice mix positive impact, clearly helping the margin. There is also everything we are doing on price and we keep clearly working in the direction of improving nicely price on combustible. There is -- and I would be happy to elaborate further if you want. Then there is, of course, everything we do on manufacturing productivity, which is also a nice driver, and then below the gross profit, you're right, we have this very positive evolution of our SG&A, where we managed to decrease on an organic basis SG&A by about 7% when the decrease of the topline is only 1.5%. So, we have a nice leverage if you want between the two. And here you have a mix of things. First of all, yes, of course, we are working on the efficiency of our -- all functions, all teams are working on working in a simpler, more efficient, more digitized manner. We are platforming our work. We are standardizing, we are automating, we are using digital in all capacity in order to work in a more efficient manner. So that is contributing to certainly some saving. Then on top of all this effort, you're absolutely right. We have increased efficiency as we turn toward a more digital…

Thank you.

Our next question comes from the line of Michael Lavery of Piper Sandler.

Good morning. Thank you. You've launched in some markets this year and certainly it doesn't seem like the easiest of circumstances to really get those going with pandemic closures and restrictions, but you've got some like Saudi Arabia already at 40 basis points of share obviously small, but France took several years to get to that. Mexico also 20 basis points. It's early but these look like they're a pretty good start. Can you touch on some of what's driving that? I know you just mentioned some of the digital things. Is that really the key, are there other factors? What's just getting some of these markets going a little bit more quickly than we've seen in the past?

Well, I think it's -- each market Michael is different. So the answer probably could require long explanation and entering the various type of dynamic. And starting with the regulation, of course, the capacity that we have to speak about IQOS and explain how it works. In some market we have this capacity to explain to smoker that a better alternative does exist in other country, we are much more limited. So that is clearly having an impact. Then certainly there is an impact as you grow the visibility of IQOS, as you people starting to see friends, family around them using IQOS, you may have a kind of snowball effect maybe it's a little bit of a caricature, but I think to some extent it can play like that and that can accelerate the evolution of the market. You have also the cultural dimension, which is quite important, in some country people will be proud of having discovered IQOS and they will want to share that with their friends and they will become our best salespeople I would say about IQOS and taking themselves the time to explain and convince friends and relatives. In other culture, it would be very different and that won't happen because they will believe that it's a personal choice and they don't want to interfere on that. So, all that to explain the very different pattern that we are seeing in terms of development of the business. Having said that, you're absolutely right. The more we're going to be able to go digital and have great digital tool to contact smokers talk about IQOS be able to engage them in what is the IQOS experience. The more we are going to be able to grow the market and clearly developing the digital customer experience is going to be key hopefully in accelerating the growth in several market. But let's not underestimate the fact that regulation can be a pretty significant restriction nevertheless even when it comes to using digital tools. So again that explain why I think there is certainly no market where we are not seeing that we have the ambition to make them RRP market, but certainly in some market it's going to take a bit more time.

Okay, that's helpful. And then we're about five months into the menthol ban in the EU for cigarettes. You mentioned a little bit of incremental momentum on IQOS menthol especially in a market like Poland. There's been a big share jump there. How much is that related to menthol success getting cigarette smokers to switch and how much more runway is there for that to go?

Sure, Michael. What I can share with you is that, so you remember that menthol was roughly speaking 10% of the EU market altogether. I think the vast majority of the menthol smokers have been switching to other type of combustible cigarettes. And so I don't think that there has been certainly not maybe what was all in term of people stopping to smoke. It's probably a few percent, but no more than that. And when it comes to switching to other alternative like heat-not-burn and IQOS in particular maybe around 5% of the people have done that so far. It doesn't mean that we are giving up. We think that we can certainly convince more people, but I think the impact has been relatively limited. You're right; probably helping a little bit in Poland. Maybe in the UK as well which two big market for menthol. But I would not say that it has been having a big, big positive impact so far on our IQOS business.

Okay, thank you very much.

Our next question comes from the line of Vivien Azer of Cowen.

Hi, good morning. I appreciate all the detail around digitization and IQOS user engagement seemingly a lot of the hard investments you guys made early and then the incremental investments are paying off. I was wondering if we could kind of pull that altogether and perhaps quantify the evolution that your IQOS user acquisition costs in particular over the course of 2020 given COVID? Thanks.

Well, I understand the question, but at that stage you know I think we are not going to enter into more granularity. I think we are giving through this set of numbers and presentation more detail on the driver for profitability. So I'm sure that you are able to capture through the gross margin evolution and other element that we are giving some elements. But it's obviously, as you can imagine, a relatively strategic information sensitive and therefore it's not something that we can share, but I'm certainly happy to confirm that we are seeing a significant decrease and that we have ambition for more significant decrease in the future. So I'm just reiterating my comment that you should expect more improvement on the ramping up of the profitability of our RRP business in the future, which is really great because we are combining a big, big driver for the top line growth quite obviously and in addition, a nice driver for profitability improvement.

Okay, that's fair. Thank you very much. My second question is just on price gaps in the heat-not-burn category, it makes a lot of sense to me that you would want to introduce a tiered portfolio as your penetration continues to mature, if you will. How are you thinking about those price gaps relative to combustibles though? I mean you've used the same kind of descriptive language in terms of the price segmentation in Russia. Are we meant to take that to understand that you're going to match price gaps against combustibles with a tiered heat-not-burn consumable portfolio or is there a reason to think it might vary? Thank you.

Well, as you know, globally we have a position because it deserves it. Our RRP business as a premium business. It's a unique consumer experience and that fully justify a premium price positioning. Now, of course, as you know in some country as well, the excise duty level is lower, sometime materially lower on RRPs and heat-not-burn then on combustible cigarettes. And therefore that is also justifying a lower price point. So, I would say, as a rule we have our combustible that are priced at the price on Marlboro or sometimes even a bit below Marlboro and I think it's a good positioning. The sweet spot to really reflect the overall experience and the value for the consumer, but also the specificity of the heat-not-burn category and heat-not-burn products. And in segmentation, we are going to do the same. It's of course related to the customer expense as well and all three consumable are under the same and not deliver the same experience. And exactly like we have been doing for decades on consumable depending on the level of, I would say, benefit value for the consumer. We know what is perceiving the overall pleasure and positive dimension for him. We'll have different price positioning that will be aligned with that. I don't think we should expect anything really materially different there.

Understood. Thank you very much.

Our next question comes from the line of Bonnie Herzog of Goldman Sachs.

All right. Thank you. Hello, Emmanuel.

Hi, Bonnie.

Hi. Your quarter was stronger than expected and you're seeing a better demand environment and then you also took up guidance again. So I guess I'd like to get your thoughts on resuming your share buyback program and if this might be realistic next year? It seems like you have flexibility and I guess I think of it as an important positive signal for the market that probably would be viewed favorably. So I just think it would probably help to support your stock price. So I'd love to hear what your current thinking is on this?

Thanks for the question, Bonnie. We haven't changed our mind at that stage on the buyback and we've announced as you know 2.6% increase of the dividend to $4.80 a year. So we continue to reward the shareholders. And I think we stated in the past and we are very much on that line that we would not start to share buyback that could potentially endanger the rating. And I'm not sure that today we have a huge flexibility on that rating with the balance sheet that we have today. So we have a very strong balance sheet and we want to keep that. I don't think that we would love to be losing some nudging the rating because of buyback. So I'm not closing the door on the long term of course it's a moving situation. And as we keep generating cash and strengthening the balance sheet, we may together with the Board decide to change that, but for the time being, this is not on the agenda.

Okay, that's helpful. And then I know it's early, but I was hoping to get maybe your thoughts on what you see as the key tailwinds or maybe headwinds as we look out into '21? I guess as I'm thinking about your business and what you've accomplished during this pandemic? It seems like the setup is quite positive especially as I think through a few tailwinds, such as, for instance the one you have in Japan. I'm not asking for guidance for next year, but is there a way that you could just kind of layout a few of these tailwinds as you see them for your business and/or possibly headwinds? Thank you.

Thanks Bonnie for not asking for a guidance because we will not give you anyway. Trying to elaborate on tailwind and headwinds. I think the tailwinds are quite obvious. We have this RRP business that is you know almost one-fourth of the business. So it's very material in term of share of revenue, that is going very strongly. We talk about growth of about 28%, 29% year-to-date. We see a number of market that are actually contributing to the dynamism. We are, as we said, enriching the offers. So we see that we start to enter into new phase of this ambition of creating this category that we think one day will be, I would say, putting an end to a smoking world by this segmentation enrichment of the offer. So we have here a very powerful tailwind that is going to help us as we enter into 2021. And as you have seen, it's not only, as I said positive for the top line, but it also nicely positive for the bottom line, because we are ramping up the profitability on that business and that is a business that has the potential to be super nicely profitable. Then of course you know I said it you have all these very low comps that we're going to have in few markets. We have this Q2 that has been very difficult. You have the duty-free business that is extremely depressed. So one could argue that if things were to start gradually in 2021 to be back to normal, but that could provide easy comp for growth. Now that unfortunately the segue for headwinds, because we don't know what's going to be the environment. More and more people are saying that we're not going to be back to normal maybe until the summer of 2021. Nobody knows what exactly it means, by the way, but people are saying, when the vaccine will be available, which could be summer 2021. That's a condition to be back to some more normality and therefore we don't know how it's going to play out globally on the business. But I think we are taking comfort and confidence from the fact that I mean the 2020 will not have been a walk in the park, that for sure, and despite that, we are delivering what I consider to be a robust performance and targeting our nice organic growth for the adjusted EPS. So it shows that even in a difficult environment, we managed to deliver a nice performance.

All right, very helpful. Thank you.

Our next question comes from the line of Gaurav Jain of Barclays.

Hi, good morning, Emmanuel. So couple of questions. One is on the CapEx. So CapEx was again reduced to $600 million and now it is meaningfully below depreciation, which runs at about $950 million for your company. So is this the new run rate of CapEx and can you depreciate a step down in the future?

Sure, Gaurav. So, no, this is not the new normal for the company. We are obviously going through stormy water. So it's an adjustment and there is number of project by the way that given the environment we prefer to postpone, so that explain why we are now targeting $0.6 billion for the year. I think you can expect us when we are back to a more normal environment, to be back to a more normal CapEx amount that I would say probably to be around $0.8 billion. So that could stay below the level. You're right of amortization and depreciation that is north of $900 million today. And of course overtime if it continues like that, that will mean that this amount will decrease as well. You're absolutely right. I'm not able to give you a phasing for that, but that should be over time a natural evolution though of course with the carryover effect it will take some time.

Sure. And my second question is on your travel retail business, where you have booked zero revenues on high cost in the Middle East and Africa line. And clearly the market is not down 100%. So you are supplying out of inventory. So is there any risk of inventory write-down in travel retail?

I think at the end of September, we have been taking care of the potential impact of that. So I would not expect anything major for the rest of the year.

Okay, brilliant. Thanks a lot.

Thank you.

Our next question comes from the line of Chris Growe of Stifel.

Hi, good morning, Emmanuel.

Hi, Chris.

Hi. I just had a question for you, if I could on some of the inventory adjustments that occurred in the quarter. And just to understand so IQOS had an inventory drag that weighed on its volume in the quarter that you reported an even stronger performance for that brand excluding the inventory changes. Our inventory say for IQOS I guess I'd be curious for your business overall. Are they at the right level or are there expected changes to occur in the fourth quarter on inventory perhaps to building inventory?

No, Chris. I think that you're right. And I think we flagged in H1 that there was a number of country with some anticipation on inventory. We got the reversal of that in Q3. You're right. If you retreat the shipment by that, we have a record around 20.5 billion stick of in-market sales which is, I mean, it's quite a symbolic threshold, but to be above $20 billion is quite nice, and we believe that we are globally at the right level at the end of September. So we're not expecting today in Q4 any material impact on inventory for heat-not-burn.

Okay, thank you. And then, just a second question on VEEV and kind of just to understand the degree to which you can undertake a wider scale launch in more markets in the fourth quarter. Are there production limitations? There obviously I'm sure there are at this point, but just to understand how you think about the progression of that launch in more markets starting in the fourth quarter?

So there could be very limited number of market launch in Q4. I think we're taking the time to have all the lesson learned from what we've seen in New Zealand to make sure that when we launch, we are super ready and very successful. There is certainly things around age verification on which we are still working and which are very important for us as you know. So we are still working on these various dimension. So don't expect too much in Q4. I think the big new launches will be more for 2021.

Okay, thank you for your time.

Thank you.

[Operator Instructions] Our next question comes from the line of Owen Bennett of Jefferies.

Afternoon, Emmanuel. Hope you're well.

Owen, hi.

And first question please. I just wanted to come back to Adams in the $250 billion target by 2025. So you mentioned the role, the expansion of the portfolio into evapor will here and obviously very different economics between heated and vapor. So how do you see that $250 billion being split between the two categories? I know very early days, but I'm kind of a rough idea internally how you see that evolving?

Sure. And so we haven't been splitting the $250 billion. So I won't do it now. I think we believe that quite obviously each RRP category has a play in getting there, but there is no doubt that we continue to see the heat-not-burn category as being I would say the majority of this $250 billion. So we certainly intend to develop e-vaping and IQOS VEEV and other things that we could launch from now until 2025. But I think you should expect still a big part of this -- a big majority of the $250 billion to come from heat-not-burn. Remember I mean this is an aspiration that we've been sharing. I think as we progress we'll make sure that we put more detail around that. So bear with us. We're going to certainly continue to give more vision, more visibility. But at this stage I cannot split further the $250 billion and quite obviously we want to develop things in a profitable manner. So that also drives the choices and the final number in the split of the $250 billion.

Okay, thank you. And second one; I was hoping you could give me the ex-inventory heated volumes in Eastern Europe that Q1, Q2 and Q3 you just see how that kind of progressing shipping the inventory impacts out?

Well, I don't have that with me, but I can see with the team maybe as to whether there is something that we can find the one for you.

Okay, great. Thanks very much. I appreciate it.

Thank you.

And, thank you, we have reached the allotted time for questions. I would now like to turn the call back over to management for any additional or closing remarks.

Thank you very much. That concludes our call for today. If you have any follow-up questions, please contact the Investor Relations team. Thank you again, and have a great day.

Thank you all. Talk to you soon. Bye.

And thank you, ladies and gentlemen. This does conclude today's call. You may now disconnect.