Good day, and welcome to the Philip Morris International Second Quarter 2022 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Philip Morris International management sessions, and the question and answer session. [Operator Instructions] Media representatives on the call will also be invited to ask questions at the conclusion of the question-and-answer from the investment community. I would now like to turn the call over to Mr. James Bushnell, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2022 second quarter results. You may access the release on pmi.com. A glossary of terms, including the definition for reduced risk products or RRPs as well as adjustments, other calculations and reconciliations to the most directly comparable U.S. 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 are to our RRPs. Growth rates presented on an organic basis reflect currency-neutral adjusted results, excluding acquisitions and disposals. Consistent with last quarter, figures and comparisons presented on a pro forma basis entirely exclude PMI’s operations in Russia and Ukraine. As mentioned previously, starting in the second quarter of 2022, and on a comparative basis, PMI will exclude amortization and impairment of acquired intangibles from its adjusted results. Today’s remarks contain forward-looking statements and projections of future results. I direct your attention to the Forward-Looking and Cautionary Statements disclosure in today’s presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. It’s now my pleasure to introduce Emmanuel Babeau, Chief Financial Officer. Over to you, Emmanuel.

Thank you, James. Welcome to you in your new role, and welcome, everyone. Before I begin, I want to reiterate our focus on supporting our employees and their families affected by the war in Ukraine and above all on the safety of our people. We continue to deploy pledge humanitarian support and additional benefits for our Ukraine employees. As previously announced, we intend to exit the Russian market in an orderly manner, as the complexities of continuing to operate in Russia increase such as supply chain challenges and financial and banking sector restriction. We continue to actively work on options for doing so in the context of an increasingly complex and rapidly changing regulatory and operating environment, including the requirement to obtain certain governmental approval for any transaction. Turning to our business. We demonstrated strong underlying momentum in the second quarter of 2022 with another quarter of positive volume supporting better-than-expected top and bottom line growth. Most impressive was the continued excellent IQOS performance and strong Q2 pro forma user growth of more than 1.1 million, demonstrating further sequential acceleration compared to Q1 as device limitation and COVID restrictions continue to ease. This reflects strong momentum in the EU region, Japan and developing market. Q2 RP pro forma net revenues grew by plus 11% despite the adverse shipment timing impact due to supply chain constraints highlighted last quarter, while HTU IMS volumes grew by plus 20%. IQOS ILUMA delivered further impressive results in its first three markets of Japan, Switzerland and Spain. The acceleration in category growth in these diverse geographies highlight the exciting future growth opportunity across the world, including in the latest launch market of Greece. In combustible, robust Q2 pro forma volume growth of plus 2.4% and organic net revenue growth of plus 4.2% were driven by…

[Operator Instructions] Our first question comes from Pamela Kaufman from Morgan Stanley. Your line is now open.

I wanted to get a sense for what's contributing to the strong IQOS new user momentum that you've experienced in the last two quarters. Is there anything that you're doing differently? And where are you adding these users geographically? How much is driven by ILUMA versus prior IQOS devices? And then related to that, what do you estimate new user growth would be if you were not constrained by production capacity?

Thanks, Pamela. So we are obviously -- and I said it very pleased with the performance of IQOS, and that is certainly being reflected in the very strong user growth of more than 1.1 million in the second quarter. We said that for H1, it's a record growth. The good news is that we are really growing across geographies. So of course, we have a number of countries such as Italy, Poland, Japan, because their size, of course, they contribute more in the quarter. But the reality is that we see very good trends across geographies. And I could mention countries such as Romania, Portugal, Hungary, I mean, these are all countries of smaller size but where the growth is really impressive. So I think it's a tribute to the fact that IQOS is making some clear customer expectation, the fact that people realize all the benefits they can get by switching from combustible cigarettes to the IQOS product. There is certainly ILUMA contributing. But as you know, we are unfortunately today, limited in the number of geographies where we propose ILUMA. It's Japan Switzerland and Spain. We've been launching Greece. So that is certainly in this country, helping the performance. But to be very clear, the performance is across the board, as I said, and including country where we haven't launched yet ILUMA. So certainly, we are improving the way we deliver a great customer experience, including digital customer, how we contact smokers, how we get in touch with them, how we start the dialogue, how we explain the benefit of IQOS and how we are leading them in the journey from moving away from combustible products to IQOS. So no doubt, we continue to improve our commercial engine, and that is helping. There is probably the impact of…

That's very helpful. I also wanted to get a sense for how you would characterize your current appetite for additional acquisitions in the near-term in light of the Swedish Match transaction. There are additional assets for sale in the U.S. market. Are you in a position to consider more acquisitions?

Today, we are focusing on Swedish Match. The time line is the one we were expecting at the beginning. We continue to expect the closing of the transaction in Q4, of course, subject to Swedish Match shareholder acceptance. Nothing has changed. We are focusing on that. Am I closing the door in the future on other things that would further accelerate our journey to become a leading and successful smoke-free company? No. But clearly, the priority and the focus today is on Swedish Match.

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

I have a question on your pro forma adjusted OP margin in Q2. It declined on an organic basis. And you did highlight that the drag on your margins, at least partly was from the higher cost of ILUMA devices and then HTUs. And then you also lowered your full-year OP margin guidance. So just hoping you could give us a sense of how long margins could be negatively impacted, I guess, from the rollout of ILUMA. And just based on your FY '22 guidance, which does imply lower year-over-year EPS growth in the second half, I assume the drag on margins could be a key driver of this in the second half, but I just wanted to verify that? And just kind of thinking out into 2023, should the drag sort of ease? Or will that continue as you keep pushing on ILUMA?

Yes. Thanks, Bonnie for the question. So I mean, that's true that in H1, we've seen a number of headwinds on the margin. Needless to say that inflation, of course, is one. And we said that we are seeing around 4% inflation on our input cost. So I guess it's probably lower than inflation that we see in many countries, but that's significant. Obviously, we have costs that are coming from the disruption in the supply chain, notably coming from the war in Ukraine. We have a dramatic acceleration of air freight that is, of course, temporary. We're not going to keep air shipping on the long term. But during a period of time, we need to do that, and it's very costly at the time where the cost of freight is globally, not only for air but globally going up. So we are obviously being impacted. So that is having an impact here. And then there is a launch of ILUMA at the beginning, notably in Japan, where we had a very, very strong investment, which was really important to make on the device. And we have two devices now offering -- three device, actually, three models in Japan, and the strong volume in device has an impact on the margin level. On top of that, we said it since the beginning, we don't start the launch of ILUMA with optimized cost and weight on TEREA and on SENTIA. And that is coming at the beginning with a negative impact on margin which something that is temporary as well. So we expect in the course of 2023 seems to gradually improve. So inflation is not temporary. I think for the rest, a lot of the headwinds that we are seeing in H1 are temporary, and there will be a…

Okay. That all makes sense. And yes, definitely a lot of moving parts. So that was helpful. And then just my second question is on your proposed acquisition of Swedish Match, I guess, could you give us a little more color on where things are? And then maybe what you see as potential risks of this transaction not happening? I guess I'm asking, thinking about the activist involvement other words, I guess, I'd like to hear how committed are you to this transaction? And how much flexibility do you have in terms of your leverage? I don't think you have a a target leverage ratio, but you've stated in the past you want to maintain your investment-grade ratings. So just maybe wanted to get a sense from you of what the rough, I guess, threshold for that leverage would be to maintain that.

Thank you, Bonnie. What I can tell you on Swedish Match is, first of all, to repeat that we have cleared the U.S. requisite in terms of regulatory approval. So that is behind us. For the rest, the processes are still ongoing in several jurisdictions according to plan. And we are confirming the fact that we expect what we said in beginning closing in Q4, of course, subject to Swedish Match shareholder acceptance. And here, I would like to reiterate the fact that we believe that this is a very compelling offer for Swedish Match shareholder. Can I remind everybody that we offered a 40% for the premium at the time of the announcement in May, since then, the markets have been quite volatile, most of them going down, and that this offer has been approved by the Board of Swedish Match, which was confirming the fact that they thought it was compelling for their shareholders. So that's what I have to say on Swedish Match. And I have no other comment to make.

We will take our next question from Chris Growe with Stifel. Your line is now open.

I just had a question for you first on the timing of shipments across the second half. You've talked about the -- just over 2 billion sticks that shifted to the second half of the year. Does that shift mostly to the fourth quarter as we're thinking about your guidance for IQOS shipments in 3Q versus what's implied for the fourth quarter?

Yes, Chris, if I can try to help you, what we expect in Q3 is shipment to be much more in line with the underlying growth that we have seen on the IMS in H1, which was around 20%. So that's what we expect in shipment, but we don't expect the recovery of the shipments that have been missing in H1. We expect this recovery in Q4, where we continue to expect very strong dynamism of IQOS consumables. But then the shipment will be in Q4 above IMS to broadly align for the year, shipment and IMS. So that is the phasing that we expect for the year.

Okay. And just one other question on relation to device sales. They've been a little elevated here as you had more availability. Does that remain elevated even in, say, the first half of '23 as you continue to build your availability of devices? And is that the right time line to think about the point where you'll have, let's call it, full availability of devices is in the first half of '23 based on the chip shortage?

I think you have two elements, Chris, here. The first one, remember, we had some constraint on device availability that started in Q2, some impact in Q3 and last year. So of course, there is an increase in the device level this year based on low comps. So that's the first element. And I think it's really important to realize how important it is to make sure that smokers can have access to IQOS device to get converted. So I think it's important that we make commercial effort here. And I think we're doing that well. And we see that our device versus maybe some device from the competition is clearly getting a better conversion. On top of it and then the second element, it is clear that with ILUMA, there is a wave of replacement. So, we see in the markets where we launched ILUMA, a rapid replacement of existing IQOS blade device by IQOS ILUMA. And that -- this wave of replacement is creating a very strong one-off acceleration in the level of device. When people will be equipped when the core consumer will be equipped that will be behind us, but we have to go through that. And that is having, again, on a temporary basis, a negative impact on the margin.

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

So my first question has to do with the proposed elimination of menthol variants in the EU for heat-not-burn products. Could you please offer some color on your menthol mix in that geography, and then secondly, an outlook on the timing of that proposal? Thank you.

Look, I'm not sure we disclosed the component of menthol. Of course, that's a minority of our business. What I can say about that is that we have to understand that this is a move in application from the TPD in Europe. So it's not a decision. It's an application based on the TPD of 2014, which in certain circumstances was planning for a kind of automatic ban to be implemented. Now this still needs to be approved by the parliament and by the European Council that will be in front of these two bodies later on in 2022, and we'll see what is the final decision. To be very clear, it already has happened on a combustible business with almost no impact or very limited impact. So, the consumer reorganize their taste and they switch to other products, but very limited impact. And therefore, it isn't clear that this will have a meaningful impact if it happens on our heat-not-burn business. In addition to that, we believe that we have superiority in our tobacco taste versus competition, and that's the superiority of our technology with IQOS versus the technology of the competition. So that will mean if we are left with tobacco taste that our product will look great versus competition for people who may decide to go for new product, if they have to abandon on flavor. So we are, of course, waiting to see what are the development. But as you can hear, I guess, from my comments, we have limited concern on that matter.

Certainly. And my follow-up question is on IQOS in the U.S. If we can just revisit the timing of reintroducing that product into the marketplace, please? Thank you.

Yes. We expect to be in a position to introduce IQOS in H1 of 2023. I cannot be more precise at this stage. We continue to work on the plan to be able to do that. And of course, we'll keep you posted when we have more clarity and more precise reintroduction date.

And we will take our last question from Gaurav Jain with Barclays. Your line is open.

So a couple of questions from me. One is on Russia. So, the way you're now guiding, you are including Russia for the full year and earlier, you had included Russia just for Q1. So can you still export devices into Russia, IQOS devices because you still have IQOS shipments there? And also, can you take cash out of Russia to pay the dividends, which you are paying in USD?

Thank you, Gaurav. So yes, I confirm that we can still export our device, not covered by sanction. And therefore, you have many parts of the business that are disrupted on the supply chain, but that one for the time being because, of course, you never know how this can evolve, is not impacted. On the payment of the dividend, I'm not able to tell you because we did not try to pay a dividend. So I'm not able to answer. What I can tell you is that for the time being, we've been making the usual payment between our subsidiary and in terms of procurement in terms of any kind of royalties or intercompany normally. So that's what I can tell you at that stage.

Okay. And my second question is on the Canadian market. So clearly, you do not consolidate Canada, but you give the volume numbers. So the market is down 16% in 1H '22 and 19% in Q2. And the retail pricing, I think, is 6% to 7%, which is not out of ordinary. And then you have mentioned in the e-cigarette cannibalization and you have launched Viva, the disposable device in Canada. So what's exactly happening in Canada? Is it that e-cigarettes are now growing very fast and cannibalizing the market? Could you just help us understand that?

Yes. I think that is a market where you may have some basis of comparison and some one-off element, but the trend is clearly don't take the minus 60% as a reference for the market. But clearly, the trend is for combustible business to go down and for smoke-free product, including vaping, but our ambition is also to grow fast heat-not-burn to develop nicely as a substitute to combustible. That's a market on which things are moving rapidly.

I would now like to turn the program back over to management for any additional or closing remarks.

Well, thank you very much for participating to this call today. We were delighted to share the very good progress that we are making on IQOS and on becoming a smoke-free company despite of fact, of course, the challenges that you all know. And we look forward to talk to you soon. Thank you very much.

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

This does conclude today's program. Thank you for your participation. You may disconnect at any time, and have a wonderful day.