Good day, everyone, and welcome to the Philip Morris International Second Quarter 2023 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Philip Morris International management and a 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 second-quarter results. The press release is available on our website at www.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 US GAAP measures for non-GAAP financial measures cited in this presentation, and additional net revenue data, are available in Exhibit 99.2 to the company's Form 8-K dated July 20, 2023, and on our Investor Relations website. Growth rates presented on an organic basis reflect currency-neutral adjusted results, excluding acquisitions and disposals. As such, figures and comparisons presented on an organic basis exclude Swedish Match up until November 11, 2023. Today’s remarks contain forward-looking statements and projections of future results. I direct your attention to the Forward-Looking and Cautionary Statements disclosure in today’s presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. It is now my pleasure to introduce Emmanuel Babeau, our Chief Financial Officer. Over to you, Emmanuel.

Thank you, James, and welcome everyone. Our business delivered outstanding performance in the second quarter of 2023, exceeding our expectations to reach a record high quarterly adjusted diluted EPS of $1.60. This was driven by impressive ZYN and IQOS growth, coupled with strong combustible results. We delivered total cigarette and HTU shipment volume growth of 3.3%, putting us well on track for our third consecutive year of positive volumes. This excellent result underpinned double-digit organic topline growth and high-teens currency-neutral adjusted diluted EPS growth. We also expanded our leadership in smoke-free products in the period. Firstly, IQOS’ strong momentum continued, with adjusted in-market sales volumes, led by plus 16%, and shipments up by plus 27%. This reflects very good user growth of plus 1.4 million in the quarter and continued strong traction across the world. This is increasingly driven by IQOS ILUMA, which is now available in 23 markets, representing around two thirds of our IQOS business by volume. Secondly, and now two full quarters after the Swedish Match acquisition, ZYN is delivering an exceptional acceleration to our smoke-free business. US volumes grew by over plus 50%, including a notable step-up in June. We are delighted with this performance. Our combustible business also delivered better-than-expected results with over plus 7% organic net revenue growth after a very robust quarter for pricing and resilient volumes. This was a key contributor to the strong plus 7% organic operating income growth, with a plus 210 basis points sequential improvement in our adjusted operating income margin. Turning to the headline numbers, positive volumes supported very strong organic topline growth of plus 10.5%, with continued excellent IQOS momentum and a further acceleration in combustible pricing. This does not include the remarkable plus 19% pro forma ex-currency topline growth of Swedish Match, led by ZYN, with…

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

Hi. Good morning. I wanted to ask about your full year guidance. You exceeded your own Q2 guidance by at least $0.13, but did not flow through the EPS to the full-year outlook, even when factoring the greater FX headwind. What's tempering the flow-through of Q2 upside, and how much does this reflect conservatism around the balance of the year versus a more cautious outlook on the second half or higher investments? Thanks.

Thank you, Pam. When we look at the driver for beating our initial expectation for Q2, I think we can probably make three buckets. One is the outperformance of ZYN versus our expectation, and that's something that we are of course taking into account as we see a better trajectory for ZYN than initially anticipated. Remember that will only contribute to our organic growth on revenue in Q4. But that is of course helping the adjusted EPS growth excluding forex. We also see some cost that has been moved to H2 and that is if you want cause that are we going to see in H2, so it's not a net addition for the year. And then there was, as we said, some better news on a financial cost of course from our debt. There was also some element on tax and of course this one is more uncertain and more difficult to predict for the second part of the year. But I think as always, we are building scenario for the full year. We've been including in a clear way what we see a real change in the trajectory and on which we have visibility for the second half on things where we have postponement of things with good news, but of course we still a lot of uncertainty on H2. Of course, we have to be a bit more cautious when we take them in the scenarios.

Okay, thanks. And then just on operating margins, you pointed to operating margins closer to the lower end of your initial guidance range of down 50 to 150 basis points for the year. Can you discuss the puts and takes impacting your margin performance in the second half?

Sure. When you look at the margin, really things are happening as expected, I would say. So, after Q1, which was not coming as a surprise to us, we said from now on, we're going to see an improvement of the margin trajectory. We knew that inflation would still be there for the rest of the year, although in the second part of the year, we are going to be facing comparison where inflation was starting to kick in, so that's going to have some impact. But we knew that a number of other headwinds would start to abate, and here I'm talking about the disruption on the supply chain and among other things, things connected with air freight, the cost attached to the launch of ILUMA, and the fact that not everything was optimal. So, we started to see improvement in Q2 as expected, and we're going to continue to see improvement in the rest of the year. And then what we see playing in Q2 that we expect to see playing in the rest of the year are the fundamental positive drivers that we have for our margin. First of all, the fact that IQOS growth is having a positive impact on our margin. We said it in the beginning, we expect a positive contribution on margin evolution for the year from the IQOS business. Remember, we have a higher gross margin rate on our consumable for IQOS. So, as we are growing IQOS, that is having a positive impact. There is no - when it comes to our smokefree business, another driver that is positive for our margin, which is ZYN, and ZYN in the US, which is also accretive to the margin. You don't see it in the organic reporting so far, but it's going to…

Thank you. That's very helpful.

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

Hi, good morning. I wanted to follow up on the commentary on ZYN, certainly consistent with the very robust trends that we're seeing in the Nielsen scanner data, accelerating growth, strong market share gains. You've spoken in the past about the opportunity to offer some incremental investment for that business unit to expand the sales force, improve distribution and drive velocity. Can you just talk to us about where you are in that assessment time horizon for ZYN, please? Thank you.

Sure, Vivien. Yes, ZYN is - I mean, we knew that the brand was great. I think we are seeing something that is above our initial expectation to be very clear for the time being, at the time of the acquisition of Swedish Match. There is clearly a growing awareness of this category. We see a lot of poly usage. So, you have a percentage that is fully converted, but a lot of poly usage. We talk about people discovering that they can enjoy their nicotine in moments where they cannot enjoy, whether they’re combustible cigarettes or other inhalable product. That is certainly playing. I think there is a very positive lifestyle element around the development in the US that is gathering momentum. So, that is, I think, explaining the success of ZYN, that is the icon of the category, and of course, taking today the lion's share of the growth of this nicotine pouch progression in the US. Now, that is very good news of course, because that means that we have a very dynamic business in the US. To be very clear, it's not marginal at the group level. So, you will see, and you already see in the performance, the impact of the ZYN US performance. So, that's great to have another driver for our smoke-free performance and globally for the financial performance of the company. But it's setting the scene very well for IQOS because on top of what is successful, we're going to be able to build a very efficient commercial engine. You said it increased sales force. We’re in the making of that. It’s happening progressively. It's of course going to help both ZYN and IQOS, but that also goes very well for our capacity to develop IQOS successfully in the future in the US. We don't have a convergence of strength between ZYN and IQOS. So, to be very clear, we haven't been suddenly increasing at that stage by several hundred people to the sales force. It's happening gradually as we build the capacity for IQOS starting Q2 next year. There is other investment that we're doing in our digital capacity and digital commercial engine. Again, just the beginning. So, I don't think it is really today behind the growth that we see behind ZYN, but these are additional strengths and capacity. And again, I think we are very excited about the amazing teams that IQOS and ZYN can be in the future in the US.

That's really helpful. Thank you for that. And then just moving to the Wellness and Healthcare segment for my second question, please, understanding some of the challenges around the clinical trial, I was wondering if you could just comment on your aspiration to delever the balance sheet post the Swedish Match transaction versus the potential need for incremental M&A as you think about an ultimate $1 billion revenue target, understanding that you pushed out the date for that. Thank you.

Yes, and I want to be very clear. I mean, the focus is on deleveraging the balance sheet. We are focusing on extracting the great potential that we have in our smoke-free business. I mentioned IQOS and ZYN together. We certainly want to grow VEEV as well. But I think there is so much potential on IQOS and ZYN that it's of course the key focus today. And we are spending our time, energy on maximizing the potential there, and that's going to generate deleveraging. So, the time today is not for us to think about, I would say, a structural move on M&A in other spaces. We are very much focused on optimizing this great potential that we have in our smoke-free business today.

Thank you.

We'll take our next question from Gaurav Jain with Barclays. Your line is open.

Hi. Good morning. So, I have a question on ZYN in the US. So, the volumes are coming in much ahead of where I think consensus is where we were. We also know that US cigarette volumes have persisted at very weak rates despite easy comps. So, what do you think is the cannibalization rate of ZYN on US cigarettes today? And as you project out IQOS growth over the next seven years, if ZYN's cannibalization is higher than what is thought of, then does it mean that the cigarette universe is smaller, which implies that the IQOS opportunity is smaller?

It’s, Gaurav, an excellent question. I believe - first of all, I'm not going to be able to give a precise answer, as you can imagine. I believe that there is probably some cannibalization for the reason I mentioned. We see behaviors developing of people that probably are aware, combustible user, and they discovered that they can enjoy their nicotine in a different manner, with certainly positive perception on when they can do it and the impact on them. Now, I'm not able to tell you whether this is something very material. So, I don't have any data at that stage. And I'm sure we'll try to elaborate on the ZYN driver on the 28th of September, but as I said, I'm not able to share with you any hard data on how it's materializing. Frankly, I don't think that this is going to be really relevant for IQOS because maybe in a kind of super marginal manner. But here we talk about with IQOS, smokers who want to enjoy when they are still enjoying today combustible cigarette, but different product that is mimicking very closely their pleasure, with clearly personal benefit on their health, but also on their lifestyle. So, I don't see the ZYN moment as something that is going to compete with IQOS in a meaningful manner. So, I think that that's not something that we see as a risk to undermine IQOS potential in the future.

Sure. Thank you. And the second question I have is on this EU heated tobacco flavor ban. And you mentioned that there could be some volatility. Now, the experience in California has been pretty bad for - post the menthol cigarette ban, and that only 70% of the menthol smoker seems to have been retained in the cigarette market. So, like, what is the precedence? Is there any precedence of a flavored heated tobacco ban anywhere which helps you form the view that the impact will be quite minimal?

Yes, there is, Gaurav. So, I will take two examples, one in Europe when there was the menthol - the flavor ban in May 2020, where it had minimal impact on the combustible business, very, very small. So, that's one illustration. And the other one is actually - because we talk about growing products. The other one here is the ban on flavor in California that impacted ZYN at the end of 2022. And there was a few weeks with a blip on the volume. And then the momentum came back on non-flavored product actually with even more intensity and blip has been swallowed, and you don't see today any impact of this ban. So, I think here you have two element experiences that show that this is having minimum impact. And again, we're comparing in California with growing a category, which maybe is more appropriate, but referring to combustible in Europe in May 2020, the impact was de minimis.

Okay, sure. Thank you so much.

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

All right, thank you. Hi, Emmanuel. I wanted to circle back to your guidance with just maybe a quick follow-on question. Your full-year guidance implies, I guess, more riding on Q4. So, just hoping you could help us understand maybe your level of conviction and or visibility that your business really will strengthen so much later this year. And then, I know it’s early, and I don't expect you to guide next year, but is there anything we should think about that you’re investing in this year that really could position you for even greater growth next year and beyond?

Yes. So, Bonnie, trying to be back on H2, I think you see it already in Q2. I mean, the momentum behind IQOS is there. We see it. We estimate 1.4 million user growth in Q2. That's an excellent number. We see in-market sales going up. We know that there is seasonality, but it doesn't mean that the consumer offtake is going to decrease. There is more launch of ILUMA and some of them that happened in the end of H1 that is going to contribute as well in the second part of the year. So, we see very robust momentum there. We see the work that we've been doing and as we said, the highest intensity of price increase has happened in Q2, is going to be lower in H2. And we've been defending our market share well in a market that is resilient. And we may discuss why CC is so resilient, but the fact is that combustible is proving to be resilient in many geographies. And then there is a ZYN moment, clearly a ZYN momentum, which we're not saying we're going to keep growing at 50%, of course, but clearly we expect momentum to continue super nicely on ZYN and starting Q4 that will also contribute to the organic growth. But in any case, it's going to fully contribute to adjusted EPS growth, excluding forex. So, all that give us the confidence that we are set for a very, very good and very strong H2 in terms of performance. Now, when we look towards 2024, we believe that the growth drivers are going to stay the same. So, IQOS, with of course the launch in Q2 in the US, but let's be clear, it's going to be the beginning. So, it's not going to immediately have a huge impact. It's going to be a ramp up, as we explained, but there will be a number of countries where ILUMA will be fully delivering. Look at Japan. That's quite interesting what happened in Japan. In fact, we've seen kind of another acceleration on market share and volume one year after the launch of ILUMA. So, it's not as if the old positive impact was happening in the first weeks. I would say takes some time to create the awareness, the understanding, and the positive appreciation. And then we're going to have ZYN and nicotine pouches. ZYN, first of all, starting in the US, but a number of exciting launch outside the US as well. So, that is boding well for 2024, but of course, it's premature to talk about ’24, and we'll give guidance in due course.

Okay. That all makes sense and helpful. And then I just for my second question, I was hoping for some more color on Japan, and it looks like your shipment volume was really strong in the quarter and then your market shares increased nicely. So, could you talk through key drivers of this? And then I believe BAT is cutting their prices on glo Hyper starting in August. So, could you talk through the current competitive environment and then maybe how you expect it might change in light of these actions, as well as how you may need to respond, if at all. Thank you.

Sure, Bonnie. So, Japan, of course, is a matter of great satisfaction. I was alluding to it, the fact that one year after the launch of ILUMA, we see a further acceleration of our market share. We are now above 26%. And as I said, that shows that the brand keeps doing inroads, converting more people, making a big difference versus competition. And we are - actually, we've seen our capture share of the growth of the category that continue to grow increasing. We have a two-tier strategy between TEREA and SENTIA that is proving to be very efficient. So, we have the premium range, TEREA, with a lot of innovation, great flavor experience. And then we have SENTIA, which is of course at the lower level in term of positioning. But with this two, I would say range, we managed to really reach the broadest possible member of ILUMA user, and that's clearly showing some great success. We are back in Japan to see freight progressively. So, that was expected. Last year, the shipments were lower than the consumer uptake. And this year, that is of course not - we're going back to the normal situation. That was absolutely planned. And we see indeed competition while trying to fight. This is a category that keeps having a lot of traction and gaining share. They are fighting to keep growing when ILUMA is clearly doing well. And so far, they believe that their way forward is to come with cheaper consumable. That's of course their decision. I won't comment on that. It's clear that despite that, we managed to grow the share. But it's good to see that there is a clear growing commitment from the whole industry behind the category in Japan.

All right. Thank you again.

We'll take our next question from Matt Smith with Stifel. Your line is open.

Hi, thank you for taking my question. I wanted to ask about the pacing of the rollout of ILUMA to 50 markets from the 23 markets where it's available today. Do you expect that to be fairly evenly spread across the second half? And could you talk about the rollout or the expansion, the impact on your operating margin in the second half, as well as your gross margin?

Yes, Matt. So, there will be a progressive difficult for me - I mean, there will be events in Q3 and Q4 of launch of ILUMA in a number of countries. It’s difficult for me to tell you whether it even spread, because I would've probably to do that depending on the size of each market, but it's going to be relatively well spread. Let’s be clear. We have already two third of the IQOS volume that are exposed or benefit from ILUMA’s presence. So, it's not marginal, but a big part of it has already been done. And as we said, at the beginning of ILUMA, we were not fully optimized on the product, on the productivity. It doesn't mean that everything will be done at the end of the year, but we expect to certainly see an acceleration of productivity, reduction in the weight in the second part of the year, and that will have a positive impact on margin evolution, absolutely in line with what I explained a number of headwinds that are receding in line with expectation. But that's really what you can expect for ILUMA in the second part of the year.

That you for that. And if I could ask just a follow-up question on the combustible performance. It's been stronger in terms of both volume and organic revenue contribution, and you made a couple of comments about the demand environment holding up better than your expectation relative to the elevated pricing. Can you talk about the factors that are allowing the consumers to hold up elasticity better than your expectations? Do you expect that to continue now that you're going to lap some pricing action?

Look, so far, I think that we've seen that pricing, it doesn't mean that the consumer is going away. I'm not able to tell you how it's going to further evolve in the future. I think what we see globally on the combustible market is first of all, a few markets where, because of the demographic, we see the consumption of combustible going up. I could certainly mention India, probably Egypt, Turkey, probably Vietnam, even if it's not a big market for us, where we see combustible business going up. The resilience is also coming from a number of markets where there is a ban on smoke-free products. So, of course, that is to some extent protecting the combustible business. As you know, that’s clearly not something that we like. We think that it's a big mistake, but that is probably providing some resilience to the category overall. So, that would be my analogy on combustible.

Thank you for that, Emmanuel. I'll pass it on.

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

Afternoon, Emmanuel. Hope you are well. So, related to heated competitive dynamics, so all three of your major tobacco peers now appear to be in a better spot, at least versus the past with regard to product offerings at least, and money they're investing into this. I was just wondering if you could comment on IQOS trends in some of the more competitive heated markets where all three of your major peers now have a presence. So, like (indiscernible) for example. So, how is IQOS share holding or ILUMA having less traction in these markets than others? Are you seeing trial of other brands and consumers coming back to IQOS? Thank you.

Sure, Owen. Actually, you may have seen that our share of the category has remained stable in Q2 at around 75%. So, it shows that indeed there is increased competition, but the quality of IQOS and notably ILUMA, but not just ILUMA, the overall IQOS proposition, is allowing us to, even if we're more premium, to maintain our share of the category, which is very good news. Here, I'm talking about volume. You can imagine in term of value, that is even higher. Now, let's be clear. Since the beginning, we knew, and I can say we were hoping for the whole industry to embrace heat-not-burn as the category of the future for inhalable nicotine product. And it's great to see a growing commitment from all the player behind that. So, no doubt that they will come with innovation. Our self, as you can imagine, we're going to continue to innovate as well. And we will see certainly innovation and maybe new things coming in the future. Now, after six, seven, almost eight years of launch of IQOS, I think in term of franchise, in term of impact, in term of strength, in term of brand power, I think we are really second to none. And we made a clear gap and differential. And I think that this is exactly what we did with Marlboro in the past, which Marlboro was a superior product and recognized for the brand that was unique. But on top of that, we managed to create a unique brand that was extremely appealing. And I think with IQOS, that's what we are repeating today. So IQOS products are clearly better recognized as such. It's a different customer experience, but then the IQOS brand is also iconic, and people are seeing that as part of lifestyle and product they want to associate themselves with, which is a recipe for long-term success.

Cool. Thank you, sir. I appreciate it.

And we'll take our final question from Jared Dinges with JPMorgan. Your line is open.

Yes. Hi guys. So, you talked about the ability to use sea freight finally to supply Japan as you progress throughout Q2. Would you be able to confirm that you're no longer capacity-constrained on the TEREA sticks?

Yes. So, we can confirm that for the market where we've been launching today, we have no constraint, and therefore that's the reason why we've been able to move to sea freight. Now, there is still a ramp-up for the remaining markets that do not have ILUMA today. And this ramp-up is of course, accompanying the growing capacity. So, it doesn't mean that today we could serve on the 1st of July 100% of all the market, IQOS market with I ILUMA consumable, but we have no longer pressure restriction and the fact that we are back to sea freight, and we have a plan to accompany the growth of the remaining markets in the coming months.

Got it. And maybe just to follow up on that, so you guys did call out Europe with IQOS, saw some further negative inventory move in Q2. Should we expect that to reverse in H2? Because actually it's been - on the whole, in H1 it's been somewhat sizable, the negative inventory.

Yes. In fact, that’s - sure. In fact, that's - Japan was finishing with lower shipment volume than consumer offtake in 2022. That has been reversing in 2023. And Europe went the other way round. Remember, we had too low because of uncertainty on the availability of product and energy supply in the manufacturing site. And that was expected, but the catchup has been happening mostly in Q1, but still a little bit in Q2. And now we expect to move to normal pattern of shipment versus consumer offtake or in-market sales. And therefore, we expect to have a strong H2, both in term of shipment progression and in-market sales in Europe, back to normal.

That's clear. And if I can just follow up just one last one. On Russia, given the news last week or this week, just can you give an update on if that business is fully ringfenced at this point?

Look, on Russia, we have nothing new to say. We've been explaining in the past communication that the situation was complex. There is no new element. I'm not going to comment on the situation of a company that I know nothing about. And we have nothing new to report on Russia at this stage.

Got it. Maybe just in terms of supply, like Russia's not supplying any neighboring markets at this point, right?

Well, we are, as you can imagine, complying with all regulation, restriction, sanction today, and we are obviously fully compliant.

Perfect. Thank you.

It appears we have no further questions on the line at this time. I will turn the program back over to management for any additional or closing remarks.

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

Talk to you soon. Thank you. Bye.

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