Philip Morris International Inc. (PM) Earnings Call Transcript & Summary

Good evening, ladies and gentlemen, and thank you for giving me the opportunity to be here with you today. And I will talk about the new purpose of Philip Morris, which is to deliver a smoke-free future, which essentially is a future without cigarettes. Now we will talk, obviously, a bit more about product and product transformation, but I will cover all the other ESG topics during the presentation. So this has the usual forward-looking and cautionary statements. I'm sure you're familiar with them, and I encourage you to read them. What is PMI? I would say PMI is known as a cigarette company. It's the largest cigarette company in the world. It was spun off from Altria. Altria Group used to own Kraft, Philip Morris International and the U.S. business, and PMI was spun off in 2008. So PMI operates everywhere in the world, except for the United States. And in 2016, after having developed products that can replace cigarettes by providing lower harmful substances to consumers, we announced a new vision that our objective is to focus all the resources of the company in the development, scientific substantiation and commercialization of products that can replace cigarettes. And the common denominator is that none of these products burns. So -- because it's the presence of combustion that creates the problem in cigarettes, and I'll come to this. Now our footprint is fairly large. We operate in 180 countries. We have -- we buy tobacco from 350,000 farmers directly or indirectly, and that's important footprint. We have 150 million consumers that buy products from us. 73,000 employees, and important also we collect $75 billion as excise taxes for the various governments around the world. If you look at the industry, totally, it's a -- including China and the U.S., it's about $860 billion retail business, of which more than $540 billion are excise taxes. So as I said, the problem we try to resolve here -- because I believe in order to have an impact, you need first to address the effect of the product you produce before looking at how you make the product, which is your supply chain footprint. So there are 1 billion people, more than 1 billion people, who smoke today around the world. And there are 35 million still in the United States. And the projection is that -- and that's the World Health Organization, that even in 2025, there will be still the same number of people as declines in prevalence of smoking are compensated by population growth. So so far, the public health efforts have been on restrictive measures, restrict the marketing, restrict access of the product, increasing taxation in an effort to prevent initiation and encourage smoking cessation. And the question here is, can these measures only, that they should not stop, achieve a future without cigarettes? And maybe it's -- you wonder why I ask this question. But the -- I would say, what we all need to understand, as I said at the beginning, is that cigarette problem, which is morbidity and mortality are causing disease and premature deaths, is caused by the fact that you burn organic matter that is tobacco. Nicotine is addictive, but it's not the primary cause for disease in cigarettes. And I'm sure we'll come to this conversation given all the developments in the U.S. regarding e-vapor products, for sure, but even the FDA clearly says nicotine is the least of the problems, except for its addiction, but not in disease genesis. And the tobacco per se is not a problem. The same way as fossil fuels are not the problem. It's the fact that we burn them to create energy that create the issue. So now that we have the technology and we have the scientific capabilities to evaluate these products, we put all our efforts to develop a portfolio of products, that I will explain later, that have a common denominator that they do not burn the organic matter, they don't burn tobacco. So some of them heat tobacco, and one of those was recently authorized by the FDA for commercialization in the U.S.; or vaporize a liquid, it's more known in the U.S.; or contain pure nicotine. And all of them are not risk-free. There is no product we can develop that is 0 risk. But because you don't burn, you reduce the toxicity very substantially. If we take, for example, heated-tobacco products, the one reviewed by the FDA, you have a 95% reduction in toxicity and carcinogenic substances compared to a cigarette just by heating at very low temperatures. And if you look at e-vapor products, properly manufactured, according to standards, we have reductions of 99% of the toxic substances. So that's the important part to retain. But at the same time, because they are addictive and because still contain some toxicity, you cannot say there is 0 risk. And all the preclinical and clinical evaluations we have done, and they have been submitted in many regulatory authorities, including, as I said, the U.S. FDA, show that you have reduction of exposure to toxicants, you have -- in our assessment, we used a threefold approach. You compare these products to cigarettes, but you also compare them to the -- to cessation. When people quit completely their use of nicotine because that's the only standard we have -- epidemiologically, we know what happens to people who smoke when they quit completely smoking. And the closer your product is to the effect that you observe clinically post quitting completely nicotine, the more confident you are they are going to have a positive effect on public health. But at the same time, to quantify exactly, we should not be confused and believe that 95% reduction in toxicity and exposure is 95% reduction in morbidity and mortality. That, we did the epidemiology over time to quantify. What we know today, it is going to be significant, but we don't know exactly how much it is. So now to do this, on one side, clearly, we had to develop the products, and back in 2016, we commercialized the first product, heated -- 2015, I'm sorry, commercialized the first product, had good acceptance and very high switching rates. It's called IQOS, but that's the brand name. Essentially, it's electronically-heated tobacco. And we started in Japan. And what we observed is, sensorially, the product is very acceptable. Although it has a deficit in terms of taste compared to cigarettes because of the very absence also of the carcinogenic substances, but has very high adoption rates. People who bought the product switch completely out of cigarettes at 70% to 75% from the first month or even weeks. And that's much higher than the rates we achieved with e-vapor products we are more familiar with because they have a deficit of taste that is even higher. So after that, we had the scientific evidence. We had the portfolio of products and the proof of these products are capable of switching people. So our decision was that now we focus all the resources of the company in order to commercialize these products and shift them away from cigarettes. And the progress has been fairly significant, I would say. But at the same time, we had to transform the company. We introduced very many new disciplines, life sciences that we never had before. All the preclinical, clinical capabilities that are very similar to the pharmaceutical industry because it is the same process of where you develop a drug, then you bring it to consumers. The -- we were a trademark company. We had to create a lot of IP, and we learn how you create IP and patents. Cigarettes have been a product that has not changed for decades or hundreds of years. So it was all about trademarks. Here, it's all about IP, electronics and so on. Secondly, change in the supply chain. We do electronics. We don't do only an agricultural product, you do a mixture of 2, [ reefers ] logistics and so on. So we had to bring in significant new talent to the company because we just didn't have the skills. I mean the whole life sciences is people from pharma that they joined the company under one condition: they will never work on cigarettes, and they never did. So -- and then at the same time, retrain the organization because now it's not a transactional product that you sell at the point of sale, it is something that you have to follow the consumer during their journey, so that they don't fall back after 1 week, 2 weeks, 3 weeks, 4 weeks back into cigarettes. You had to digitalize the entire system because we started manually, and we had already 5,000, 10,000 incremental people on the ground dealing with people, explaining to them the product, what it is, what it's not. But you had to start digitalizing, otherwise it's not scalable. So many new disciplines, and we did it through a combination of bringing new talent in from the top but, most importantly, retraining the organization because I think that's the right thing. And I get the question very often: why didn't you just leave this product on the side and create a new company with new products. Well, if we say we're going to replace cigarettes over time, I believe that you cannot leave your organization behind. And this is not a line extension you put on the side and you say, it's -- the whole effort of the company is to convince people to switch out of cigarettes. And the second thing is we would never have the access and the resources and -- that cigarette business gave us to retail to consumers and initially, obviously, the cash flow, but that you can forget because the products today are still profitable. So here is, as I said, the 4 platforms. One is heated-tobacco electronically with all the connectivity that this may have to help consumers during their journey. We have what we call Platform 4, which is a more typically vapor product, and on which, by the way, we will implement age verification for activation of the device because the technology exists now. So to minimize any impact on youth -- which means if you buy the product, it doesn't operate until you have age-verified registration. That's one measure, of course, there are more. So I will not spend much time on the platforms, but they took a lot of time to develop because we try to make products that are as close to the ritual and taste of smokers as possible, otherwise, they just don't switch. It's not that you just give them a nicotine product. It's not enough. You need to convince them, and it takes a lot of time and effort. And as I said previously, the most important thing here is we knew as a company that we have a deficit of trust regarding the science. That's for sure. And I knew very well we don't have a second chance. This time, all the data is going to be under scrutiny. So we try to do it in the best possible way, bearing in mind that when we started this process, the FDA had not even issued their guidelines on how you develop, evaluate and survey post-market these products. So we started assuming it's going to be like a pharma process. We were right at 95%, so we didn't waste a lot of time and effort, but it was a shot in the dark at the beginning. So that's the good thing, all the data is available on PMI Science, and anybody can buy the products and verify because they exist today in plenty of markets. The other important factor here -- I'm sorry to -- the other important factor is that conversion capability of the product because to have an impact to public health, it's not sufficient to have a reduced harm product. You need people to adopt it. The same way it's not that it's good to have solar panels, you need people to use them. And for this, you need to incentivize them, and you need to put all the commercial effort and emphasis behind your products, once you're convinced that they are better than the previous ones. So after 4 years, essentially, we are in 52 markets already worldwide. Not fully covering all the countries as we enter new countries gradually, but we cover already 45% of the world consumption and expanding constantly. And the most important part is 71% of our marketing and sales money is behind these products, whilst they only represented last year 19% of our revenues. So at least, I think, we are putting our money where our mouth is, and the results are good so far. We had 14 million people who used just the first platform, IQOS, and close to 10 million have fully switched out of cigarettes. So they don't use cigarettes anymore. And if I illustrate Japan that was the first market, the heated-tobacco category in Japan is already 25% of total cigarette consumption. And the good thing is we didn't reverse the trend of prevalence decline, but we made an enormous difference in terms of reduction in consumption of cigarettes, which is the biggest public health effect ever achieved in terms of cigarette consumption reduction in the world. So these interventions can have an impact. I was saying this before, it's -- this transformation changes the company from every angle. From the employees, and I talked about them, the products themselves, the commercial effort, but then we look at our supply chain. All these products use less tobacco. So not only we have the natural decline of cigarettes that is very gradual, 1% to 2% per year worldwide that affects the farmers, but at the same time now, we have products that use 1/2 or 1/3 of the tobacco. So a key constituency here is the farming communities and how you help them do crop diversifications, change because it's not so easy. Tobacco has one big advantage for farmers, it's a cash crop and they sell what they produce, and there's no price fluctuation because this is not a commodity. It's not a stock market-traded commodity. So to convince them to move to other things is not the simplest thing on earth, and that's a lot of effort. That's what requires a lot of collaboration with society in general and regulators, and I'll come to this. So -- but I'm sorry, if we can go back one. If we can't, it doesn't matter. And I mentioned also from an organizational perspective, we are dealing now with electronic products. We had no idea how to do electronic products, to be frank with you. I mean we had -- we didn't have call centers. We didn't have reverse logistics. We had to do all kinds of things of recycling and circularity as we go forward and so on. So I think it's a big change, and we managed to carry the organization along during that change. So to be very -- I believe that if you don't measure things, they don't happen. So this is the metrics we have in terms of the product transformation. I'm not talking about all the other such ESG aspects. We have plenty of those, and I'll come to them. So we have -- 98% of our R&D expenditures are already in the new products. I talked about commercial expenditures, and our objective is to be, say, at 38% to 40% of our revenues and more than 40 million people that have switched out of cigarettes into our products by 2025. That is what we can achieve alone, meaning without regulatory intervention, what changed in the existing regulatory regimes that do not differentiate in their vast majority products from each other. So if we move -- before I go to the external environment, the question is, why does it make sense for us and for our shareholders? Well, already, we have 55% of all these new categories in terms of retail revenue. We have the first-mover advantage, and we established a new brand. Our brand used to be a cigarette brand, Marlboro, known by everybody almost. Here, we are creating a new brand that will have most of these platforms under heated tobacco, e-vapor, whatever. And already, if you look at our retail share of cigarettes -- outside the U.S. and China, it's 30% -- we already have 55%. So it makes sense. Margins at the marginal level is better because some of these products are recognized not being cigarettes, so they are taxed a bit more favorably. But of course, we had all the infrastructure expenses. Now the products are accretive to the bottom line. So it makes sense to do it financially. And yes, we recognize -- I recognize we had to build a different infrastructure for all the reasons I explained. It's all the research development cost without just incremental marketing spend, $7.2 billion cumulative so far. But now that we have the infrastructure, we can leverage it to have much more products and much more fast -- faster to consumers, all the expenditure is just incremental. And I was talking about the support now to accelerate the pace by the regulatory community and governments and public health. And I must say these products are polarizing in public health, especially given the recent events in the U.S. where there is a real problem, which is the increase in experimentation of young people with nicotine products. Although the cigarettes declined, we had a real big jump in use of e-vapor products by youth, that's a real problem. And then the recent unfortunate deaths and disease we had with lung diseases where initially people thought this is e-vapor product -- traditional e-vapor products, and the reality was, unfortunately, people took open systems or others and put oils -- cannabis oils, and the lung system is not made to dissolve fats. So it was an unfortunate situation, but this has nothing to do with what happened with e-vapor products. Now clearly, there was a lot of misinformation around this. And the misinformation led to the fact that the categories stopped growing, not only in the U.S. but worldwide. And there is -- because there are people opposing these products -- and it's normal when you have innovation and new things, you will have always people that are for and people that are against, fact of life. But the reality is 50% of people smoke in the U.S., roughly the same in the rest of the world, believe that e-vapor products are equally dangerous to cigarettes or even worse, and that's inaccurate. So -- and the confusion very often leads to people continuing to smoke. And some people, because of the confusion recently, went back to cigarettes, which is not really something we would like to have in public health. So I think that it's very important that we have cooperation on this and support from public health -- I'm sure there will be questions on that, so I will not elaborate -- because that can accelerate quite dramatically what we try to achieve here. And it has to be transparent from both sides. Now we've done a thorough materiality analysis, and not surprisingly, there are 3 things that came up strong were the product change, the responsible marketing and youth use of the product and the third is the farming community. And everything comes after, which is expected so. And we have prioritized 4 areas with primary metrics for all these areas. I will let you read it, and we have attached all the metrics to our presentation. So whomever is interested, we have the sustainability report, they're all there. We measure much more than that in terms of impact, but these are the primary things, society told us you need to focus, and that's where we're focusing. And for 4 categories, we have very clear objectives. I talked about the first 2, which is youth prevention and unintended audience use and the 40 million, as a minimum, people that we would like to switch by 2025 if we continue under the current regulation. The third one is 100% of farmers making a living, so we can eliminate child labor. We have very good agricultural labor practices product -- program. I think it's probably one of the best in FMCG categories. We still have -- we still -- we have 97% farmer compliance with child labor practices and forced labor sometimes. We still need to work with the rest, but that's an enormous progress. And in certain countries, the tradition is so strong of using children during school holidays that it's not so easy to fix. But I think that's the objective by 2025, and be Scope 1 and 2 carbon neutral by 2030 and, obviously, the entire value chain by 2050, earlier if possible. And we are making very good progress on all of those. In terms of governance, we have the full support in this transformation of the Board of Directors, clearly. Yes, we have separated roles of Chairman and Chief Executive Officer. I think the Board has experience in many fields and, clearly, as we transform the company, there is common understanding that we have to continue renewing the Board and bringing also new Board skills in. That's necessary, and you can read the rest. But -- and the last thing is both our short- and long-term compensation, [ minor and ] the senior team, are all linked to the transformation of the company and related metrics. So I would say our priorities -- clearly, our priority is the product and the commercial effort behind it. The second thing is we are doing a lot of things in the ESG area, but we have not talked about this because we gave priority to the product. I think we need to increase much more the engagement with ESG investors. I know that there are discussions of excluding entirely sectors from ESG investment. I don't think, personally, that's going to change anything in terms of consumer behavior and people's behavior because excluding a sector does mean -- say, tobacco, it doesn't mean that the people who smoke will quit. Or excluding certain oil sectors, it doesn't mean people will stop consuming energy. I think by including people -- companies in the investment that try to do the right things and working with them and encouraging them and sometimes giving feedback on how do we do better, I think that's a better approach to have real impact long term, if we believe in this. So essentially, I believe it makes sense for us as -- from a shareholder perspective to do what we do. Definitely, it makes sense for our consumers. And I think, overall, we are -- if we are successful, we will have a much more sustainable business. And if the regulators stop hesitating and start playing the game much more like the FDA does, here, I think we can accelerate this 40 million to much, much higher, and probably in 10 to 15 years in certain countries start talking about phasing out cigarettes. So that's all I had for you.

As a reminder, for the people that are not in the room, you can still deliver questions via Slido. We can start in the room. Back here, it looks like we have a question.

Thank you very much for the presentation. I do have a question around your marketing practices -- global marketing practices. There was a Stanford study done recently where they presented evidence that you are marketing via social media and organized events that had youth as early as -- or as young as 16 years old. So you mentioned several times that you're trying to change your marketing practices to adult only. So what is your minimum age globally of target audience or target market? And then also what are you doing to ensure that those are met by all your new marketing divisions?

Okay. First of all, internal alignment is fundamental, and we do continuous reviews. Materials are reviewed by our law department, by external affairs department, by management. That's obvious. And I think we have enough experience in cigarettes and knowing what not to do for so many years that it's kind of natural rather than start-ups that didn't know which industry they're in. I would say that regarding the new products, but also existing -- but let's take the new products. I think we should be looking at measures of what effectively happens, not saying that maybe this visual or this execution may be attractive to young people. So so far, we have no red flags because we do post-market surveys, okay? Recently, there was a study sponsored by the Minister of Health of Japan that I mentioned in CAGNY, only 0.1% of school-age teenagers used IQOS when the product is 18% market share, okay? Now what you are referring to, it was an influencer program that we used in certain occasions at the beginning in Russia where we had put a threshold of 25 years old smokers to be qualified as influencers, and the agency didn't follow. So we stopped the entire program of social media worldwide, okay? And we are reviewing the situation. So if somebody gives us feedback, we can act. I cannot guarantee and nobody can guarantee that there will not be 1 or 2 problems somewhere. If we get feedback, we can fix them. There is no systemic need to do that. And I think that's where monitoring eventually is important. So we have conducted a very thorough review because we had the shareholders' request. We found that in the vast majority, it works well. There are things to improve. We have work to improve them, and we will do these reviews and, eventually, we'll start introducing external verification as well to double lock it. But the most important thing is go back -- and we have a golden opportunity, as I say. We need minimum age for purchase of products. That exists almost, I'd say, in every country of the world, okay? Maybe somewhere, I don't know, it doesn't exist, but practically in every country. We need enforcement on retail. And in some places, it's not easy. You have Indonesia with more than 2 million retailers, 1.4 million in the Philippines. It's not so easy to go and enforce this, okay? You enforce it in the 300,000, 400,000 outlets, your sales force do. But it's not an excuse, I'm saying, sometimes there are material issues. And as we know, if teenagers try to find the product, they will. So in the electronics products, we have the minimum age. We need to continue education of the trade. We need to educate teenagers differently. I told my children don't smoke and my daughter came vaping, and she told me, "But I don't smoke, Dad." And she is right, she is not smoking. So we have to tell them don't use nicotine products. And finally, with technology, lock the device and unlock it only once your age is verified, then I think we minimize the probability that we have access by youth. Can we eliminate it completely? Hopefully. But I don't think this is reality, okay? But not the problem we had here.

Are there any more questions from the room? Over here.

So I had a question about -- for any industry going through a transition, there are often trade-offs between environmental and social issues. And so could you shed a little bit of light on -- well, within social in your case, the lives of tobacco farmers and how to manage that transition as you go through this product re-envisioning?

Well, there are differences. They start with, yes, as you say, upstream supply, there will be less tobacco over time. But we have to work and we are working with different institutions and educating the farmers to switch crops. This is a slow process. So it works -- and still we use tobacco, okay? It's not -- except in these products, you'll use half of the tobacco because in a cigarette, half of the tobacco you burn it in the air to use it as an energy source. Here, you don't need it because you have electronics heating. So at the end of the day, we also need to bring to the farmers, other industries in a way that we can guarantee them for 3, 4 years, that somebody will buy their crops when they make the transition to new crops. So we need to work from all sides. Of course, we can help them from an agricultural point of view because we have technicians on the ground to do other crops. That's not the issue. It's to convince them to do it because they want to have a guarantee that they're going to get some income in the initial years. And that's where we're open to partners from food and other industries, if we can find a good solution for both, that would be great. If we look at electronics, for example, we need to start recycling electronics now. And also we are looking at reutilizing the plastics and everything in certain additions of the product because I think consumers can find it even cool from that perspective. That is all recycled materials. So that's a new area that we have to learn and be better because we didn't know how to do it. So I guess, overall, I don't think the transition is worse than before, but there are new areas that we need to master. On the other side, we continue the energy reduction. Certain processes with the new products are more energy intensive, but that's okay.