Philip Morris International Inc. Barclays 19th Annual Global Consumer Conference

Good morning, everyone. Thank you for being here. I'm Pallav Mittal, Head of Global Tobacco at Barclays. I'm thrilled to have Jacek Olczak here with me, CEO of Philip Morris International. Thank you so much, Jacek, for giving us this opportunity to host you. We will start with a few comments from Jacek, and then we'll move over to Q&A. Over to you, Jacek. Thank you.

Thank you for having me. I guess we are recovering from a long weekend, at least in the U.S. Some recovering just from a jet lag, so everyone should have a bit of forgiveness. The standard slide in the beginning, including the forward-looking and our cautionary statements, which as always, we encourage you to read. Earlier today, we issued a press release, revising our full-year guidance for currency only. Now we're cruising at the spot rates at a favorable currency impact of about $0.24, at $0.24. We also give an update how we see the currency impact on the Q3 results. So we're turning into 1 cent at the current spot rate favorable. There are a few big ticket items, if you like, which are happening this year, at least for PMI. One is obviously the tax price change situation in Japan.

If you remember, the prices taxes, excise tax went up on April 1. Now we're going into second stage of a tax increase and a price increase. The prices has been registered by all the main players, including us, so we have a visibility how it's going on. I have to admit that obviously, in a country when the prices is not happening very frequently, the absolute amount of the price increases, it always creates some sort of a shockwave at the market, at the consumer level. Especially that this time we had, this year we had asymmetry between a heat-not-burn category and the cigarette category. There is one more excise increase in the near term happening as of April 1. This will touch also cigarettes and heated tobacco products.

But I think so far the market is, category is doing very well if you consider the magnitude of the changes which the consumers have to go through. So categories resuming to the growth. Obviously, there was some sort of a loading, deloading, pantry loading by consumers level. This whole thing has stabilized what we have seen over the last period before entering into October increase. I think it's all going in the right direction. The world before the full year, we're still aiming at the net adjusted basis IMS growth in Japan, obviously at the different levels that we used to have in the past. But I think if the category goes through this magnitude of changes, so April, now October, and the next April price changes, I think it all goes well for the future of the category.

If you remember, about a year ago, the category of this year, the category has exceeded 50% volume terms, not value, volume terms of the total nicotine market. Japanese market is essentially combustible cigarettes and heated categories. IQOS somehow holds the very high share of the segment, despite the fact that there were different pricing strategies, if you like, or tactics applied by the competition, and IQOS is at the high end of the market at the premium. It actually went very well. This is an IQOS. Second thing is obviously U.S., and over the last couple of months, literally two months, as we announced, as we were guiding the market before, we have extended the portfolio of ZYN, our flagship pouch product, into the moist version and the higher nicotine. This goes under the trademark of, or under the label of ZYN Ultra.

In a very short period of time, the market has introduced more than 20 SKUs. There is the massive effort on building a distribution, but also a massive effort to communicate this change to the consumer because from one day or another, in many accounts, all of a sudden, the portfolio rapidly expanded. Consumers have to find out what is this new ZYN, both in terms of a nicotine strength, but also the flavors. There is more thing coming into the market as we speak, but our strategy for the U.S., on the pouch market was very clear. We would like to obtain a sort of a symmetry in the market, our portfolio versus some other products, some other brands.

Also having in mind that this course historical price premium which the ZYN was carrying from the time, which essentially was by far the only player in the market. Despite the fact that we believe ZYN can carry the premium, we need to adjust the premium to something which is more manageable. We are doing this also while we introducing the new products to the market. We are doing a conversion from a 15, which is a traditional pouch count can in the U.S. market, we are going to the 20, creating some extra value to the consumers. The lift is going to help tremendously and already is helping ZYN today, what we see from at least the last period's performance, but very much is going to support the future ZYN growth in the market here. We are very pleased with the developments.

Obviously, we are all watching carefully the FDA and how this regulatory environment is playing out. Are we getting more and more clarity? Are we in a perfect situation here? We are not. Are we happy with what we have today, with all the PMTAs which the ZYN portfolio has received? Absolutely, yes, because everything adds to our clarity, and we can construct the plans more solidly going forward. On the combustibles, which are doing on the face value, a bit better than one could expect from the past.

But if you zoom in into which markets, et cetera, the combustible volumes are doing better than expected, I think there is a very strong correlation, the markets which do have some sort of a significant penetration of a smoke-free product versus the markets which do not, for very much regulatory reasons, our consumers can't enjoy the access to the smoke-free product. So clearly, these better combustible volumes are coming mainly from the markets where SFP, smoke-free products, are not allowed or not marketed, are not commercialized. And it somehow also reflect the underlying dynamics, the demographics, et cetera, population growth, GDP, and some other factors which we all know. But having said so, yes, the category is doing a bit better than we thought.

From our side, nothing wrong with this one, but our focus was and is and will be on the smoke-free product and opening the new markets and obviously U.S., which is a very big, very great opportunity in front of us, but also the markets in which we already have a significant position. I mentioned Japan, but very much European Union. There's also the pockets of geographies when the unit profitability is more attractive than the rest of the world. And that's from me. I guess you will have some questions.

Sure. That's some very good context, and we will go into the details on IQOS, ZYN, and combustibles one by one. But if you could just start high level, and as IQOS and ZYN and smoke-free penetration continues to increase, what we have seen over the last few years is you have had low double-digit, low teens EPS growth. Do you think that growth is sustainable over the next few years as you expand into the market?

Yeah, that's our midterm algorithm, and I do believe it's an attainable algorithm, and obviously, the quarters may differ, et cetera. But if you take a bit longer outlook for us, I think we can deliver in these ranges. Now, this is all based on the major shift which has happened at PMI over the last good few years. Okay, we started the smoke-free implementation of the smoke-free strategy about 11 years or so ago, as we remember Japan and then the Italy. But the very important is that we brought the whole company volumes into the growth, and actually, we're shooting for a six consecutive year of a total volume growth. So I think we start delivering a much better quality of the revenue growth that we used to have when we were very much the combustible cigarette, the cigarette company. We all know the algorithm in the past.

There are a few things which we retained, and the current past and the current performance proves that we still command quite a pricing power, if you like. There is a pretty solid pricing coming from a combustible cigarette year-over-year. But also there is some pricing coming from a smoke-free product, very much from the heated tobacco products category. Obviously, to the different extent because the dynamic is different and the strategy is more into go after penetration, grow the segment, maintain leadership, or establish a leadership position in the segment. So you need to balance the share aspirations, volume growth aspirations, and the price somehow in this equation. But the both categories, combustibles and the smoke-free products, are contributing to the pricing variance in addition to the positive volumes. This is very good. If you look down from the top line, the rest is, we know that this is not the extremely CapEx or COGS, if you like, heavy category.

The margins at the gross level are very attractive, and the rest is essentially the reflections of a strategy of how far we want to go and open or penetrate or, as I said earlier, grow the leadership or solidify the leadership in a category. This is very much, if you like, discretionary marketing type of a spend, which depends on the elections we make in a given period, may go up, may go down. So I feel pretty confident that the earnings at the bottom line is going to grow, and we're going to hit our algorithm.