Good day, and welcome to the Philip Morris International First Quarter 2023 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Philip Morris International management and the question-and-answer session. [Operator Instructions] I will now turn the call over to Mr. James Bushnell, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2023 first quarter results. You may access the release on pmi.com. A glossary of terms including the definition for smoke-free products, as well as adjustments, other calculations and reconciliations to the most directly comparable U.S. GAAP measures for non-GAAP financial measures cited in this presentation and additional net revenue data are available in the exhibit to the Form 8-K published this morning and on our Investor Relations website. Growth rates presented on an organic basis reflect currency neutral adjusted results excluding acquisitions and disposals. As such, figures and comparisons presented on an organic basis exclude Swedish Match up until November 11, 2023. Today's remarks contain forward-looking statements and projections of future results. I direct your attention to the Forward-Looking and Cautionary Statements disclosure in today's presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. It is now my pleasure to introduce Emmanuel Babeau, Chief Financial Officer. Over to you, Emmanuel.

Thank you, James, and welcome everyone. I am pleased to report that Q1 performance exceeded our expectations, with strong underlying momentum from IQOS, ZYN and our combustible business. As mentioned at our full-year earnings in February, we expected this quarter to be the weakest of the year due to a confluence of transitory factors impacting our top- and bottom-line. In this context, our business delivered robust results and we look forward with confidence to the remainder of the year. Smoke-free net revenues made up almost 35% of total PMI, despite the impact of adverse timing factors on HTU shipments, with an increasing number of markets crossing the 50% threshold. IQOS continues to deliver strong share and user growth across its geographies, both with the blade version and ILUMA. Where launched, ILUMA’s excellent traction with both existing IQOS users and legal-age smokers is boosting growth, demonstrating the dynamism and importance of our ongoing innovation. ILUMA’s progress is especially notable in the first launch market of Japan, where share growth has accelerated in recent quarters. In combustibles, accelerated pricing across a range of markets helped to deliver robust organic net revenue growth. Swedish Match delivered impressive results, with a stand-out performance from ZYN’s 47% U.S. shipment volume growth compared to the first quarter of 2022. Following an encouraging start to the year, we are well set up to deliver strong performance in 2023 including excellent top- and bottom-line growth for the remainder of the year. Turning to the headline numbers, our Q1 organic net revenues saw robust growth of 3.2% against a very strong prior year quarter with organic growth of 9%. This reflects the continued strength of IQOS and a step-up in pricing but was partially offset by expected HTU inventory movements, which I will come back to. This organic figure…

Thank you. We will now conduct the question-and-answer portion of the conference. [Operator Instructions] We'll take our first question from Bonnie Herzog with Goldman Sachs. Please go ahead.

Thank you. Hi, everyone.

Good morning, Bonnie.

Hi. I guess, I have a question on your guidance as it relates to Q2, it does now seem to be a bit lighter implying a lot more of the growth is now expected to be in the back half. So just trying to get a sense of how conservative your Q2 guide might be? And then really, Emmanuel, how much visibility and confidence you have that your business really can accelerate and outperform the second half? Maybe you could highlight for us some of the key puts and takes that give you this confidence and maybe where you see the greatest potential upside and also just color on [Indiscernible]

Okay. No, sure, Bonnie, happy to do that. And I guess, thanks for the question, because that helps me clarify certainly the phasing of the profit generation this year. I think we are not coming with any different method from what we said back in February. We always said that we would be facing in the first-half of the year a number of headwinds on profitability that there would be some inventory movement playing. We highlighted that and we clearly said there will be margin improvement coming in the second part of the year and we are coming today exactly with the same message. We are pleased to have a Q1 that is above our initial expectation. We never gave guidance until today on Q2, but I think what we're seeing today on Q2 is coming with a lot of positives. We are explaining that we do expect an acceleration of the top line. We are talking about high single-digit growth that we are targeting for the second quarter and that's of course going to be a very nice contribution to the performance in the second quarter. That is highlighting the momentum that we have on the business that we see behind IQOS that is not capturing the ZYN growth for the second quarter. So ZYN is just coming in addition to this organic growth. So I think it gives an idea of how nicely up and running and dynamic is our business. Now in terms of margin, it is true that again in Q2, we're going to have a number of headwinds and notably at the level of the gross margin. So we're going to continue to have a number of impacts coming from inflation. This is going to be progressively corrected, but I think you should expect another quarter with a gross margin rate declining in a material manner versus 2022. And then the second part of the year will be still showing improvement again in line with our initial thought. Where I guess you're going to start seeing in terms of margin evolution some more positive impact, this is on the revenue -- sorry, SG&A to revenue ratio where we have seen a deterioration in Q1. I think I'm not saying that we will have SG&A growing at a lower pace than revenue in Q2, but I expect the growth of SG&A in Q2 to be closer to the revenue and therefore that will weight less on the operating income margin. But that's really what you should expect in terms of sequence for the year. Again, we expect very nice acceleration for the top line just confirming the nice momentum that we are experiencing in the business and we have this ramp-up on the margin that is coming progressively. It's going to show up first at the level of the SG&A on revenue. And in H2, we are expecting as we said a better evolution of the gross margin rate. So far, we're just confirming initial expectations.

No. That's super helpful and just sounds like you've got some pretty good visibility. So that's yes definitely helpful. And then, I guess, just maybe a quick high level question on the health of the consumer in, sort of, your key markets. If you could kind of touch on that for us? And then in the context of that, you've certainly been putting in a stronger combustible cig pricing. So just love to hear a little more color on how the consumer has been responding to those actions and really how confident you are that you're going to be able to continue to push through that pricing for the remainder of the year? Thanks.

Yes. I'm not going to say that we don't see any pressure on the consumer in the world. It is quite obvious and of course you are not talking about the U.S., which -- maybe you could deserve a separate comment. But it is clear that in countries such as the Philippines, for instance, we see some impact on the business coming from purchasing power. I think we see some of that as well in Indonesia. So they are markets where there was already some pressure on purchasing power particularly leading to some downtrading and that has continued to play as we progress through the beginning of 2023. But I have to say that in many markets, we haven't seen clear signs so far. We have to stay very cautious of course of pressure on the consumer all your massive downtrading. We don't see that. The Marlboro market share was a bit down, but I don't think that is clearly reflecting at that stage a pressure on the premium product of our portfolio. And we've been increasing price as you have seen in a very significant manner. Of course, competition not immediately or not totally responding to our price increase that can have an impact on our market share, but I would say so far, we have the feeling that in a highly inflationary environment, the consumer is ticking as normal and is not seeing as an issue to see also price increase on his tobacco product.

All right. Thanks for that color, Emmanuel. I appreciate it.

Thank you.

We’ll take our next question from Gaurav Jain with Barclays. Please go ahead.

Hi, good morning and thank you for taking my questions.

Good morning, Gaurav.

So the first question I have -- good morning, so the first question I have is on FX. So in February, you had guided for a $0.15 headwind. Now it is $0.30, Egyptian pound had depreciated by Jan. And then, yes, yen has gone down a bit, but euro, which is a much bigger currency for you, is up also a bit more than that. So ruble can't be that big, right? Or is it becoming bigger this year versus last year? So could you just help us explain the effect.

Yes, Gaurav. So I think you rightly pointed to the ruble actually, if you are not going to disclose currency by currency, but if you look at the ruble, just the ruble is more than the net impact of $0.30 that today we are anticipating for the year. So I think it shows a very strong impact of the ruble. And the Egyptian pound continue to devaluate after January. So it's -- I'm not sure we had the full impact of the Egyptian pound. And actually, if you accumulate ruble and the Egyptian pound, you have 80% of the net impact of $0.30, it’s a net impact. Don't get me wrong because you have also the yen that is quite negative. And then you have the euro and a number of other categories that is positive. But I think with the ruble and the Egyptian pound, you have a pretty good explanation of the net impact. I hope it's helpful.

Okay, sure. And second, the U.S. cigarette volumes industry level are quite weak, minus 9%. And then looking at the European data that you shared, it is -- the industry volumes are flat on what were already very strong comps. And the reasons what have been mentioned for the U.S. industry weakness, which is macro, weak consumer, stimulus payments going off, disposable e-cigarette growth, I could apply the same logic to EU consumer -- EU smoker and still the volumes are so much better than trend. So is there a -- can you explain like why are the U.S. smoker and EU smoker, why are they behaving so differently?

Gaurav, I cannot -- and I will have to consider that I'm not the greatest specialist of the U.S. consumer for combustible cigarettes. So I wonder myself to given an analysis. I think it's in line with my previous comment on the fact that so far, we have been a pretty good resistance from the consumer to same price increase and coping with inflation in Europe. I'm not able to tell you why there is a difference here. We know that the social model in Europe is different. You may have some more protection, some more safety needs that are playing and maybe limiting the impact of inflation. There was maybe more compensation given from various government on trying to fight again energy price increase and sometimes compensating of agricultural product inflation across a number of geographies. So that can be one element to explain why the European consumer is resisting better. But I'm not going to pretend that I have the perfect answer to your question.

Okay, thank you so much.

Thank you.

And we'll take our next question from Pamela Kaufman with Morgan Stanley. Please go ahead.

Hi, good morning.

Good morning, Pamela.

I was hoping that you could elaborate a bit more on your SG&A investment for this year? What are the key areas that you are investing behind and the step up in that investment in Q1? I guess how much of this reflects structural increases in inflation driving higher costs versus incremental investment that you're making behind ILUMA and your Health and Wellness and Swedish Match businesses?

Again, I'm going to try to go as far as I can, as you can imagine, some of that is super sensitive, so we're not going to share in detail what we are investing and where. First of all, trying to give you perspective for the full-year, we believe we're going to have our SG&A growing faster than revenue organically. But nevertheless, we expect a limited discrepancy between the two. So that means that as we progress through 2023, you should expect the growth of our SG&A to converge with the top line growth, I'm speaking here organic. And Q1 is really, I would say, impacted by a number of one-off both, by the way, on the basis of comparison, if you look at our Q1, Q2, Q3, Q4 numbers last year, sequentially, you will see that Q1 was very low, both because we did not invest at the same moment of the year. So there is a phasing in investment and also because there was some one-off positive last year, so don't take Q1 as a reference. Having said that, we are facing inflation, of course, in our SG&A. It's a lot of people cost. And of course, we are increasing salaries. But we're also indeed generating some efficiency. So that is giving us some leeway to invest on our priority. It's about, of course, commercial investment on our priority, as you can expect. So it's everything on marketing commercial to boost IQOS. That is, of course, a big driver. It is the investment that we are making to prepare the U.S. We talk about the investment that we are making in Wellness and Healthcare. We continue to innovate a lot. We have innovation in the pipe for all our smoke-free product. And of course, that is also having some impact. So that is really what is driving this growth, and we continue to see as important this capacity that we have to cope with inflation, to invest for the future and at the same time, to have an SG&A evolution that thanks to the dynamism of the business is allowing us to still generate nice operating income and net profit growth. That's what I can share with you.

Okay. Thank you. And then can you talk about your change in your e-cig strategy? What prompted your strategy towards IQOS view? And how are you thinking about the category over the long-term and your participation in it?

Look, I think we've already been clear that while we were clearly developing some offering on the vaping category, this was not our priority. We had IQOS. And now I would say we are even more taken by two priorities, which are IQOS and ZYN. When you have such a fantastic team and the potential that they have to deliver very strong top line growth, volume growth, revenue growth and in a very nicely profitable fashion, that's really the priority. I guess you listened to us at CAGNY and we expressed the questioning that we have on the vaping category today, which are around the absence of clear regulation in many country. The fact that, that is giving way to an appropriate marketing activities, risk of underage consumption. And also the fact that this is a category where so far it's difficult. I'm not saying impossible, but difficult to see a lot of profitable model being developed. And therefore, that is pushing us to look at that and continue to work on this category and the fact that we are coming with this evolution of the range, I think, is just in line with the fact that the technology is evolving. We see the customer needs evolving as well, that's why we are developing VEEV now. But we're going to be focused. So it's not going to be across geography. It's going to be where the vaping category is relevant. It's going to be where we have a differentiation where we have the commercial strength to make an impact. And I think it is a much better strategy to do that, develop a few successes instead of exhausting ourselves in trying to develop something global today, when we don't see necessarily the ingredient of the driver for that to happen in an interesting manner, both in terms of growth, top line and bottom line progression.

Thanks. That’s very helpful.

Thank you.

And we'll take our next question from Vivien Azer with TD Cowen. Please go ahead.

Hi, good morning.

Good morning, Vivien.

So my first question is a follow-up to Gaurav's, please. In terms of your current FX outlook, does that contemplate another devaluation of the Egyptian pound, because my understanding is that's pretty well expected at this point?

So it does not because, of course, we don't have any idea of what it could be, when it could happen. So these are really an average that we take on the spot in the day before the announcement and not taking any kind of forward-looking or whatever consensus for currency evolution. You have a lot of people today that believe that the euro is set for a nice wide against the dollar in the coming months. Frankly, we're not betting on any kind of possible evolution, but really just working on the spot.

Okay. That's fair. I understand you're not in the business of predicting currency. It just seems like this is tied to the IMS bailout. So it seems reasonable to that. My follow-up question then is on the Swedish Match margins, which came in quite nicely. I was just curious, given the incremental inventory benefit that you saw in California, like how should we think about the 1Q margin in context of a normalized margin? Was there an incremental margin benefit that we should be backing out mentally as we think about what the appropriate level of profitability is for that business? Thank you.

Well, Vivien, I think what I can share with you is that I believe Q1 is just the bright confirmation of what we said, i.e., Swedish Match is coming with a very nicely accretive impact to the PMI growth. It is true for the volume, it is true for the revenue, and it is true for the profitability. So indeed, ZYN growing in the U.S. very nicely, and I don't come back on this north of 30% growth without the impact of California. That is driving a business that is nicely profitable, that is itself accretive to the Swedish Match average business. And therefore, of course, to PMI. And it is just very good news to have this engine for growth. Frankly, I mean, I don't want to repeat myself, but IQOS and ZYN together, that just a very exciting pair, and ZYN is coming as a very nice top line and margin enhancement role, and we expect that to continue.

Understood. Thank you very much.

Thank you.

And we'll take our next question from Andrei Condrea with UBS. Please go ahead.

Hi, Emmanuel, thanks for taking my question.

Hi, Andrei.

Hi have -- two from me, please, if you don't mind. Firstly, on the input cost inflation side of things. Obviously, your ILUMA margins will have efficiencies coming online later this year. But in terms of the other headwinds you flagged, leaf and acetate tow is there any color what you can give on just how big these headwinds are?

Well, they are very material, but we flagged that. And I think once again, we explained that in Q1, and we expect that to continue in Q2. This big increase in energy price, leaf price, acetate tow is going to be the biggest driver for the pressure on the gross margin. Now as we enter the second-half of the year and notably towards the end of the year, we believe that these elements will be -- well, first of all, will be facing already with some of the bad news in H2. So of course, the period-on-period comparison will be, of course, easier. And then we keep working on productivity. We may keep working on our COGS to see all optimization. So this negative pressure and nothing is going to disappear, but it's going to ease versus what we are experiencing in H1. But I would expect in Q2, the pressure to remain very strong at that level.

That's very clear. Thank you. And my second question is a bit more long-term. Obviously, we saw one of your peers come out with a new product at the Investor Day for the nicotine pouch space for the U.S. And at the same time, your other peers bringing the European product in. Is there a scope for a similar innovation for ZYN, given the criticism -- well, rather than drawback it has -- it being of a much drier product versus the -- yes.

Yes, I believe that with Swedish Match, we have the biggest specialist, super-focused, knowledgeable player of the oral nicotine category. So we've been adding to that amazing skill, the 13 -- you may remember that we bought this company that is specialized in formulation of product some of them, including nicotine, and that can also come with very nice innovation in the form factors. So you should expect us. Of course, don't expect me to come down with detail, but you should certainly expect us to come with nice innovation. There is certainly the appetite in some area from the consumer to try new things, new [Indiscernible] with product to develop this oral nicotine category in other spaces, probably the consumer doesn't know as well what can be done, so it's for us, it's our duty to come and make some proposal. But I guess you can expect us, and I think we demonstrate that PMI and now in the PMI per Swedish Match to be leading innovation in this category as well in the future.

Fantastic. Thank you very much.

Thank you.

And we'll take our next question from Matt Smith of Stifel. Please go ahead.

Hi, thank you for the question.

Hi, Matt.

The incremental number of IQOS users stepped up in the first quarter to about 900 million additional users on a sequential basis. Can you provide more details regarding the favorable conversion trends you've seen behind ILUMA? And should we expect IQOS user growth to accelerate in the second-half as ILUMA capacity improves and you expand the geographical footprint of the product?

Thank you. So yes, we are close to 1 million additional IQOS user in Q1. It's a nice number. It's not something that we can beat. I think that there is opportunity to further accelerate as we continue in Q2 and beyond. But first of all, I would like to have a few words of cautiousness. It's not a scientific number, that's an estimate, and that can have some variation depending on the number of elements. But I think, directionally, it is correct, and I think it shows the very strong momentum of IQOS. It is confirmed, of course, by the consumer offtake that we've been describing. It is clear that ILUMA is helping this conversion. So what we see with ILUMA is a higher capacity to convince smokers, because it is a more seamless experience. There is no cleaning. It is even closer the ritual of the combustible cigarettes. The overall experience is more satisfying. So the abandonment rate is lower. And of course, we talk about net user acquisition, so that is also helping. We have very nice progression of the consumer satisfaction in all countries. That is -- I guess, probably supporting the lower abandonment. So it is clear that the more we go for ILUMA, the more we are in the capacity to accelerate conversion. Japan, I think -- I mean, we're coming with a number in Japan and you can build the history. I think Japan is providing a lot of interesting information, because it took some time. I mean the acceleration that we have since Q3 in Japan is quite spectacular, frankly, and probably goes beyond our expectation. But it shows that ILUMA is probably -- gradually getting traction with, I don't know, it's a word of mouth. And -- but the consumer is realizing that this is making a big impact. And frankly, the acceleration of the market share to north of 26%, and I'm not talking about Tokyo, but average Japanese market share is a significant acceleration. It started in Q4, but it accelerated, and it's one year after the launch. So it shows that not everything is happening in the first quarter of the launch. I think we're showing a number of chart here showing that. And that bodes well for a nice ramp up in the coming quarters as not only do we have to start to launch ILUMA in a number of countries, but we know that this positive effect will spread over the coming quarters. So we take that as a nice driver for user acquisition growth in the coming quarters.

Yes. Thank you for that detail. And a follow-up on a comment you mentioned on the call about maintaining profit growth in the U.S. as you launch IQOS. Can you talk about the investment needs in the U.S. to support commercialization? And how the $75 million or so of investment here in 2023 against this begins to build out the infrastructure necessary for a broader IQOS launch?

Yes. Well, that's the additional investment. But of course, we are already starting with some investment in the U.S. We'll come at the time of the Investor Day in September with detailed plan on how we intend to grow IQOS in the U.S. And at that time, of course, we share much more color on the level of investment that we believe is going to be necessary. I think the important message, because we have a lot of questions here is the fact that, yes, of course, in order to express what we think is a great potential of IQOS in the U.S., investment will be needed. By the way, we've been investing to build this phenomenal business for IQOS in Japan and Europe. I mean we've been investing. It didn't come by chance. So we will invest in the U.S. But what we are seeing is that, given the growth momentum that we have in the business, we think that investing in the U.S. behind IQOS will, first of all, provide even more momentum on the top line and that we can absorb this investment, while continuing to grow the bottom line very nicely. We're not ready to compromise on bottom line growth because of investment that we need to make in the U.S. If I want to repeat something that I said already, I think the question mark will be, what is the differential that we can generate between top line growth and bottom line growth? Remember, the last algorithm was 5% and 9%, above 5%, above 9%. Well, if we increase more than 5% the gross rate perspective, it doesn't mean that we're going to keep a 4 points of difference between top line growth and bottom line growth. That's the sense of the comments. I hope it's helpful.

Very helpful. Thank you very much.

Thank you.

We'll take our next question from Jared Dinges with JPMorgan. Please go ahead.

Yes. Hi, guys. I want to ask about ZYN growth in the U.S., which seemed to actually accelerate in the offtake data, despite the base continuing to grow, and it's actually pretty sizable now. Do you think there's any benefit there from the investments that you started to make as part of your IQOS preparation in terms of building out maybe a sales network? Are you also increasing SG&A investments in ZYN alone? I'm just thinking of this in the context of the brand is getting bigger, we're seeing the cigarette data has clearly been very weak, but yet the trend continues to do very well. So just trying to understand what's really driving that?

Thanks, Jared, for the question. Well, first of all, yes, we are, of course, extremely pleased with the performance of ZYN in the U.S. And I want to pay a tribute to the work that the team is doing there, which is absolutely fantastic. No, I don't think that there is yet a sizable impact coming from our investment in the U.S. I think it's being developed on the merit of the great commercial plan and action. The brand has amazing traction. I think that it's extremely highly regarded by the consumer premium brand, a very nice franchise. And they are building on these two drivers, as explained, one geography. The other one is consumption per store. We just show that two things. One, of course, we have enriched the full geographical coverage. And that's where probably in the coming quarters, you will see some acceleration as we're going to put more feet in the street and more capacity to visit retail stores. And the other thing is that there is a growing knowledge, understanding and appetite for the category and for ZYN that epitomes the category, and that's what we are seeing. So, so far, no really increased investment behind the natural increase when you have such a nice growth, of course, increase investment year-on-year. So we do increase investment in the U.S., but nothing, kind of, at the stage accelerated plan and not yet impact coming from investment on IQOS that should come in the future.

Perfect. Thank you.

Thank you.

And we'll take our final question from Priya Ohri-Gupta with Barclays. Please go ahead.

Hello and thanks for squeezing me in. Emmanuel, I was hoping that we could touch on your cash flow performance in the quarter a little bit. It sounds like the weakness was somewhat related to timing factors, because 1Q is seasonally your weakest. But if you could just walk us through sort of what the drivers for that negative cash flow from operations figure.

Yes, absolutely. So indeed, Q1 has not been great in terms of cash flow performance. But that was, again, expected. That is linked with the timing of shipments, excise duty payment and some of the working capital. And there was nothing surprising. I mean, I would prefer to see higher operating cash generation in Q1, but that was expected. And we are absolutely confirming the objective for the year of an operating cash flow between $10 billion to $11 billion.

Okay. And then just a housekeeping item. Can you give us the pro forma leverage, including the benefit of Swedish Match, for a full-year versus the reported numbers that were in the release?

No, I don't think it was in the release. I don't know whether we'll communicate that. But I mean, you can come to it. I'm not sure to understand fully what your question I think you have the data to calculate things, but you can come back to us and we'll see whether we can show where the information is available.

Sure. I think that the sequential increase in leverage, if you put in a full-year's benefit of Swedish Match, just closer to about 0.2 of a turn versus the higher figure that was reported directionally.

No, I think you're alluding to the fact that we concluded 2022 saying, well, we are around 2.9 times, but of course, that would be lower and significantly lower. And maybe about what you are seeing here, if you were to take the full-year of Swedish Match.

Okay, perfect. Thank you so much.

You’re most welcome.

And there are no further questions at this time. I'll turn the call back over to the management team for any closing remarks.

Thank you all for joining today. That concludes our call. 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. Thank you. Bye-bye.

Thank you. And this does conclude today's program. Thank you for your participation. You may disconnect at any time.