Good day, and welcome to the Philip Morris International Fourth Quarter 2020 Year-End Earnings Conference Call. Today's call is scheduled to last about an hour, including remarks by Philip Morris International management and the question-and-answer session. 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 fourth quarter and full year results. You may access the release on www.pmi.com.

Thank you, Nick, and welcome, ladies and gentlemen. I hope everyone listening to the call is safe and well. Our business delivered a robust performance in 2020, despite the unprecedented challenges of the global pandemic. Most impressive was the continued strong growth of IQOS, which made up over 10% of our volumes and almost a quarter of our net revenues for the year. The daily consumption of HTUs by IQOS users saw minimal impact from social restrictions, and despite significant constraints, we were able to continue acquiring new users switching from cigarettes at a very good pace to reach a total of 17.6 million, of which 12.7 million have switched to IQOS and stopped smoking. HTU shipment volumes grew 28% compared to the prior year, with record market shares in key IQOS geographies in Q4. Moreover, 10 markets exited 2020 with double-digit national share in December. Our rate of user acquisition was again strong in Q4, propelled by the increasing sophistication of our digital commercial model and the positive word-of-mouth effect from this increasing prominence, despite tighter restrictions in a number of markets.

Thank you. We will now conduct a question-and-answer portion of the conference. Our first question will come from the line of Bonnie Herzog with Goldman Sachs.

Hi, everyone. Emmanuel, I was hoping you could talk a little bit more about your expectations around margins, in terms of any favorable fixed cost absorption you expect as you amortize the investment behind IQOS over this increasingly larger accelerating volume base. Could you just talk about that and how big of an impact this could be or how big of an opportunity this could be in the future? Thanks.

Sure, Bonnie. Happy to do that. It's going to be only a teaser versus what we're going to see next week. So bear with us, and we'll elaborate with much more detail. But I can certainly anticipate a few headlines on what we'll share next week. I think what is obvious in our numbers for 2020 is the fact that, beyond the great performance of IQOS, we have also used efficiency on cost as a powerful lever to generate performance. That's really showing up very clearly in our numbers. So we are delivering in two years, instead of three years, the overall at least $1 billion savings. What is good is that we are working on cost efficiency on several levels, and many of them, of course, are related to IQOS, but not exclusively to IQOS for some of them. If you look at the gross margin level, it's quite obvious that we are being very successful in generating manufacturing productivity, and that's a great driver for further margin improvement. Here, we are working globally across the portfolio on margin improvement. So it's not just on IQOS, even if probably on IQOS, because that's a business that doesn't have the same maturity, we have more runway to improve productivity. We are making extremely good inroads in that respect, but we are also generating manufacturing productivity on CC. In terms of our SG&A, I think you can identify two drivers on cost efficiency: First, we are working to be a more efficient and agile company. We work on being more digitized, simplifying the way we work, automating, and standardizing, allowing us not to be cost cutters, but just to take costs down to be a better company and deliver overall higher performance. Secondly, there are elements connected with our commercial performance and not only IQOS, but certainly mainly IQOS. You have the investment we made in the past, which is a great platform on IQOS. I’m not saying that the investment is over. We will keep investing, but we have now an investment that we amortize over a fast-growing base. We are not growing the level of investment at the speed of the growth of the IQOS business. Great work is being done thanks to digital and all the learnings we are gathering on the IQOS business, nicely reducing all the variable per-user costs.

Okay. That was really helpful. I appreciate that. And then my second question is on the progress you've made with IQOS in growing the base, but as you look out, could you talk about further segmentation of markets with your different platforms or possibly different price points as you continue to convert more smokers? My guess is you’re going to touch on that more next week. But I think about it, and I assume more of the conversion is going to come from other reduced-risk technologies. How do you anticipate your mix evolving over time? Thanks.

Yes. I'll give you the first shot. I still believe, over the next three years, that heated tobacco technology will be the prevailing technology because it has the highest ability in terms of taste and satisfaction to convert people. In terms of segmentation, I believe, in most markets, we will need one or two heat-not-burn technologies, and probably two to three, over time, consumable price segments, so we can cover the vast majority of the market. There will be exclusions where you need to cover four price segments with probably two technologies. We'll talk next week about the next step in technology for aerosolization in heat-not-burn, which will address many of the pain points consumers have today. The heated tobacco product is one category that I think is the fastest growth, both in terms of revenue and bottom line and volume. The second is obviously e-vapor. We are entering this market because I believe there are consumers that want to switch to these products. There are a lot of dual users, and we see dual users between heat-not-burn and e-vapor that we would like to capture. I think we can also capture consumers for every e-vapor product. The key is clearly to leverage the infrastructure and the brand name of IQOS. The product is very good, and that's what we hear from the first reactions, but we need to build equity because that's a problem for the category, and also consumer loyalty because for the economics to be at best for e-vapor, you not only need to be premium positioned, but you also need to have loyal consumers. If you discount just products and sell them, and then a consumer has ten different products from ten different competitors and consumes half a cartridge of your product per week, it's challenging to maintain an infrastructure. We have the advantage of leveraging a lot of infrastructure with IQOS. The equity of IQOS is undeniably the best in the reduced-risk product space, so I think that's helpful. Technology is good, and we are premium, so I think we can make inroads in this category. We are also going to expand in pure nicotine products like nicotine pouches or P3 over time, although these are more occasional use products or non-predominant use products. That's a brief overview, and again, sorry to cut this here, but we'll elaborate more extensively next week.

I expected that. So very helpful. Thank you so much.

Thank you, Bonnie.

The next question will come from the line of Michael Lavery with Piper Sandler.

I just wanted to touch on IQOS again. In the Philippines, you have a 20 basis points share, which, of course, is small, but it's very early there. If I understand you right, you launched there without any stores initially. You also mentioned some digital launches in Estonia, Kuwait, and the Maldives. I would love a little more sense of how some of those digital efforts work. It seems in the Philippines they're ready to be pretty quickly effective. Can you just bring to life a bit how you're going to market there?

Yes. It's Jacek here. We started this year in the Philippines, to be precise, in Manila, not even greater Manila. The product starts getting good traction. This was one of the first fully digital launches, also driven by the fact that we had to change the strategy last moment due to the COVID restrictions and the whole COVID impact. I think we'll stay for a while in Manila. This is not a major secret because we're following the same strategy for the rollout in every geography, especially in sizable geographies like the Philippines. The product is well-received, and I think the taste characteristics fit very well. We are also testing different route-to-consumer models, as we are entering the countries. There is a lot of consumption on trade rather than just off trade. We need to come up with good solutions there. I’m very positive about this part of Asia, which is still uncharted for IQOS.

That's helpful. And just a second one on buybacks. Helpful clarity that there's no consideration on that in the guidance. But with some currency tailwinds now and the balance sheet where it is, it certainly seems like that could come into play. Can you give a sense of what you would need to have in place or see before you might trigger resuming with buybacks?

Look, if you bear with us until next week, we'll have a global review of our capital allocation strategy, and we'll address all components at that stage.

If I could just maybe swap that question then. Could you give any sense of where you stand on Platform 2 with TEEPS? Any update on that?

On TEEPS on Platform 2, we will be conducting a market commercial test this year in 2021.

The next question will come from the line of Vivien Azer with Cowen.

I wanted to also drill down on IQOS. I was wondering if you could give us some color on what the mix looks like for the consumables from traditional tobacco flavors and some of the novel flavors that you have in the market.

That's Jacek here, Vivien. It varies from market to market. Obviously, as you know, we have flavors of menthol and other flavors. But still, IQOS, frankly speaking, in most places, its attractiveness comes from tobacco flavors. Most of the segments which we are targeting at this stage are in the tobacco flavor type segment. IQOS has a winning proposition in both menthol and our flavors. This varies by country, and giving you the international share of the flavors would be misleading. If you have a predominantly menthol market like Japan, menthol would dominate, while in predominantly full cigarette markets without menthol, it's more about tobacco flavors. So it follows, typically, if you have a predominant menthol market, the dominance of menthol will be higher, while in full cigarette markets, the traditional flavors will reign.

Understood. And my follow-up also on IQOS, please. Can you contextualize the contribution from the Marlboro brand versus the HEETS brand in terms of the market share progression you saw in Japan either in the quarter or over the course of the year?

The Marlboro brand is still the major contributor to the overall volumes and growth, so we're very pleased that we continue growing Marlboro. Obviously, HEETS had a bit better dynamics than Marlboro, but both contribute to the growth. It's very interesting because this is the first market where we try a dual positioning of the consumables, Marlboro and HEETS in Japan. We also extended HEETS in a couple of Eastern European geographies, in Russia. The introduction of above premium propositions to HEETS, the HEETS Creations, contributes positively. HEETS Creations in Moscow constitutes about 10% of the overall HEETS volume. We complemented this by bringing the lil Fiit proposition, and now in Russia, we're testing whether IQOS can operate across three essentially price segments on the devices. The price spread is phenomenal, going from a $60 premium device down to a $20 lil device. This gives you a hint of how broadly we now cover with IQOS, touching the segments above medium and below medium, despite competition in Russia.

The next question will come from the line of Gaurav Jain with Barclays.

So on the organic margin improvement, which you are guiding to for FY '21 of 150 basis points, that is on top of a 240 basis point improvement in FY '20. This saw benefits like production and travel expense and a cut in German VAT, et cetera. Is your underlying margin improvement closer to 200 basis points, not 150 basis points, and is that how we should be thinking about the next few years?

For the medium term, again, we'll elaborate next week on more outlook. For the year, Gaurav, I'll let you make your assumption. We are clear on the one-off savings that we have seen due to COVID, so you can factor that into your model. We are also clear on the drivers for margin improvement, which include the positive impact of the growth of IQOS in terms of per stick revenue and margin, alongside everything that is happening regarding cost efficiency. That is really what has driven the margin improvement in 2020 and will continue in 2021. Beyond 2021, we'll elaborate on that next week.

Sure. My second question is on the European Beating Cancer Plan, which was released earlier this week. They discuss flavor ban, plain packaging, and increasing taxes on heated tobacco, equal to cigarettes. How do you incorporate these risks into your outlook?

First of all, this is a plan, and there are many positive aspects to this plan. First, we don't talk about taxes. This is subject to directives, the tobacco excise directive that governs the excise tax and the tobacco product directive, which pertains to product regulation. The first directive today does not foresee reduced risk product categories, so it has to be amended. No one has said that taxes will increase on tobacco products, nor e-vapor products at this stage. Our view is that the absence of combustion is a key criterion for how to tax differently from cigarettes. Within that major change in toxicity and exposure, member states can have different tax rates for these products. This product should not be, by any means, higher than any combustible category available. But this has to happen. I wouldn't be particularly worried about this at this stage, and I think the outcome may be positive as there is an opportunity to discuss these elements. In the long term, we discussed often that tax differentials will be maintained because it makes sense for public health and consumers. We have room even to pass taxes if, by any chance, differentials somehow close, because IQOS has a mid-price position and its price productivity is much higher than cigarettes, so passing on a tax results in less price elevation. That’s in a nutshell how we should look at it, but we need to assume that excise taxes will increase over time for RRPs as governments need money. This will apply to heated tobacco products, which are already taxed substantially and potentially in some cases to e-vapor products in the future. But all of this is included in our assumptions.

Sure. And if I can ask one last question. It's on minority interest, which has been increasing at a higher rate than your EBIT, driven by the Philippines. So is there an opportunity to reduce your minority interest considering your partner in the Philippines trades on the exchanges at a multiple of around 6x PE?

No, we don't envision this at this stage. If our partner wants to sell one day, we can discuss, but at the moment, they’re very happy with us.

We're very happy with our partnership in the Philippines.

The next question will come from the line of Adam Spielman with Citi.

I think you said in your guidance that you're expecting to take less pricing variance on combustible cigarettes than usual. It has been around 6%, and I think you said it's something related to COVID that you want to take less pricing. I'm really surprised by that. If you take less pricing in combustibles this year, 2021, what would it take for another low year in 2022? That’s my first question.

We didn’t say we will take less pricing. Where the pricing opportunity exists, we will take pricing. The model still works well. We had to make reasonable, conservative assumptions regarding what's going to happen in Indonesia and Russia because of the tax increase. In Germany, we had a VAT tax break which we assume will not continue this year. Excluding these elements, we're back to normal pricing in other markets. We need to watch more carefully the price gaps at the mid- to low-end of the market, but that doesn’t mean severe pricing decisions anywhere. This is just a watch out. If there is down trading, it's something to monitor. I believe we're in a good position overall. The excise taxes are now in, so we have visibility on that front.

I don't understand the EPS guidance. In Q1, your comp is very hard, yet you're expecting flat organic sales, margin expansion, and 8% like-for-like EPS growth. But because the comp is easy in Q2, you imply that it will be a great quarter. Why is the full year only 9% to 11%? If you can do so well in Q1 and then not in Q2, then your full-year forecast seems conservative.

I wouldn't say conservative, but it's not bullish either. It’s the beginning of the year. Many uncertainties regarding COVID are still present. Last year, we incurred more than $150 million in exceptional expenses due to COVID. There is a need for some cushion in the bottom line regarding unexpected costs. If there is a rebound, we may need to invest more towards the year-end to accelerate acquisition, which would affect the bottom line. We provided a guidance at this stage based on several factors, including strong results from Q1, but we acknowledge we do not have a crystal ball and uncertainties remain.

In terms of the sequence, please factor in that we are expecting a gradual recovery without being able to precisely define the trajectory. This implies more investment in H2 as we may have been limited in commercial activity. H2 could present a better moment overall, thus explaining why Q1 looks stronger than one could have initially expected.

Anyhow, I would prefer to be conservative and provide better guidance as the quarters unfold. If the pricing comes more favorable, it goes straight to our bottom line. If we have more combustibles, that also benefits us. As the quarters pass, we will give better outlooks.

The final question will come from the line of Robert Rampton with UBS.

Hello? Hello?

Operator, can you put Robert Rampton in the queue from UBS, please?

His line is open.

Robert, can you join? Okay. We'll get back to Robert after the call, operator. If we can just go to the final remarks. Andre, I think you have some closing remarks.

Thank you all for joining. I think we had a rather complicated 2020, but the results came out much better than I would have thought when we were talking for the first time in March. I see very good recovery in 2021. IQOS continues to grow strongly, and the momentum is excellent in my view. We will see a rebound in cigarette volumes in the next 1 to 2 years. I hope to see a positive total market maybe in 2022. We look forward to sharing more on our long-term growth and insights on IQOS profitability next week. Have a very good day, and thank you for listening to us.

I just wanted to add that if you have any follow-up questions, you can contact the Investor Relations team and check our website for the instructions on how to log on to the Investor Day event. It starts at 8:30 Eastern Time on February 10. You can register on our website. Again, thank you very much for joining the call. Have a nice day.

Bye.

This does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines.