Philip Morris International Inc. (NYSE:PM) Chief Executives for Corporate Purpose CEO Investor Forum 2023 Call November 14, 2023 11:00 AM ET
Company Participants
Jacek Olczak – CEO and Chairman
Conference Call Participants
Unidentified Company Representative
[Abrupt Start]
…is really some of the most transformational efforts happening in business. Inevitably, when we send out invites to investors, both here and who are here in-person and those online, we’ll hear from a few. I don’t even want to hear from the tobacco industry, but I can assure you, you ought to. This is one of really the truly great, I think, transformational stories we have in the industry.
And with that, I am delighted to introduce Jacek Olczak, CEO and Chairman of PMI. And I think you’ll really get a sense of what’s happening. And it’s not just talk. It’s real world action they’re having. Jacek?
Jacek Olczak
Thank you. This is a very panoramic setup, I realize. It’s very good for exercising. Before we go to the more formal remarks we present for today’s event, I guess I need to press the button and to draw your attention to the forward-looking and cautionary statements part, all the materials will or are being already posted on our PMI website, so you have an access to all this information.
So before I speak, and I am very pleased to see a lot of familiar faces, which who are – know actually almost as much as myself about the Philip Morris journey to the smoke-free. And they were with us from the very early days where I remember myself when I was in the role of CFO and some of my – few of my investors asked the question, they got your innovation about the smoke-free products by, while the fact you tried to break the toil of the cigarette business. And I was the CFO trying to convince that actually the new business will be much better business than the business, which we used to have, which I believe many in this room and online will agree, but a lot of the shareholders, investors very well for many decades.
But we actually think it was the time and thanks to the technology and the science we could address one of the most important problem of cigarette, of the combustible products was to address the health impact. And you know the idea was not new to the industry. However, there was no technology or science to translate this idea into actions and to demonstrate in a real world that these products actually can help the smokers who otherwise would continue smoking, not only to permanently switch and leave the cigarettes behind, but also over longer period of time start unwinding many of the negative health effects.
So just to put it in context, the whole notion about the tobacco harm reduction, which is in the position if you like, the tobacco harm elimination, which have been a practice in the world for many decades, three, four decades, and this was nothing about reminding quite rightly, making people aware that the smoking caused the serious health diseases, that the best thing smokers should do is to quit smoking, increase the health warnings, improve the – increased very drastically in many places in the world taxation and correspondingly the prices et cetera restrict to absolute zero the marketing practices and many, many other things which we have spent or regulators have spent over the last 30 or 40 years.
And then came that moment that we all recognize it doesn’t work, in a sense that the smoking rates in many parts of the worlds are stubbornly high. If you come – if you overlay it with the growing populations in many parts of the world, the net-net results unfortunately maybe whether we like it or not, is that the years from now we will end up with more smokers in the world than we have today. And the WHO itself come up with the estimates that today is about a billion smokers in the world, and that number at best can stay flat if actually the growing populations as I said in the parts of the world will continue actually the number starts growing.
So that’s the fact number one, despite all the efforts of harm elimination part of the health intervention is not working, that what else they can do in order to improve or help smokers who want to quit. And can something which I do admit that retrospection from today’s perspective sounds very simple, that you know industry has been historically investing into filtrations and having many other methods trying to reduce the negative impact of smoking, all of these whole things didn’t actually work, didn’t yield the right results either from a consumer acceptance perspective or the reductions in exposure to the toxicants was so minimal that nobody could [indiscernible] this is some sort of a breakthrough thing.
And then here we are, and essentially the line which we can draw, because what makes the product very harmful and the products which are significantly less harmful is the fact of the combustion, which when you light up a cigarette, the lead of the cigarettes goes in several hundred Celsius, I always have a problem translating this to Fahrenheit, forgive me for that. But once you unleash this combustion process in a cigarette, you essentially are releasing in a tobacco aerosol, in a smoke aerosol the entire Mendeleev table, where the many substances which are extremely deadly, including carcinogens, et cetera.
Now if you lower the temperature to around 400 below actually level, you will volatilize nicotine, but you will not release most of these substances, including carcinogenic substances. Very often in our communications, we use that abbreviations of a harmful and potentially harmful substances, they are various risks produced by the – created by the reputable authorities including WHO, including U.S. FDA and many other regulators at Canada, and we always operate in accordance with their directions.
So the products which you have, categories of the products which you have on the chart here, being inhalable smoke-free products, including the vape products and the heat-not-burn or oral smoke-free products, [indiscernible] nicotine like the pouches, they all would offer the reduction of exposure of this toxicology, the level of 90% to 99%, which obviously any toxicologist would tell you that if you have such a massive reduction in exposure to the toxicants, the positive health effects versus [technical difficulty] it’s fair to assume that is going to have.
So this is the context in which we operate, maybe a billion smokers worldwide, no solution find today other than obviously continuing encouraging them to quit smoking. But the prevalence rates are stubbornly high and actually in some countries growing, but we know that there are products which can reduce, in the meantime, if people don’t quit, switch to these products and they start benefiting from that thing.
Philip Morris is, I guess most – many of you know, is a global company. We have a very global footprint, operating 180 markets, 80,000 people, 53 factories, 24 factories already now have been repurposed to smoke-free products. This all has been achieved in less than 10 years. Very importantly and you will find it later in my presentations, that how we also should and do care about the environment, climate, et cetera because we are to a large extent, very large extent dependent on agricultural product, which is either tobacco or the paper materials, which are coming from the forest et cetera.
We have more than 220,000 contracted tobacco farmers and more than 30,000 suppliers. So every transformations, every change in the company, if you really want to make it in a very sustainable method, we need to take into considerations that we are not acting in one market, we are thinking in a global basis, also subject to the various regulatory and other regimes and we need to make this whole thing happens, which is not that easy often.
When we start designing and a few other executives in the company, the whole transformation somewhere around 2040, when we have enough of the confidence that the products are not only good from a scientific perspective, i.e., we can have a very strong science substantiating that these products are better than continuing smoking cigarettes. We also thought that because of our size, we need to bring a lot of clarity and transparency, both to our external stakeholders, including shareholders, very much also to our employees, et cetera.
The net result, one of the net outcome of this was that in 2020, we have published in our proxy statements, the Statement of Purpose, which essentially clarified, first very important thing, this product, smoke-free products, we do not consider as the addition to the combustible cigarette portfolio. But the aim of the – objective of the company is essentially to eradicate smoking.
This is a very important change in a strategy, or it’s very important component in election of the strategy, because it informs all the resource allocations, but also and again, there are many other things, which we have included in this Statement of Purpose. And as I said, brings a lot of clarity between the external world, but also very importantly to 80,000 people in Philip Morris, who not that long ago, less than 10 years ago were essentially devoted of production to manufacturing and selling cigarettes.
The transformations, which we embarked is built on the three pillars. One is the product transformation, and I will talk about the examples of the products, which we have today in the portfolio, these internal transformations, they are capabilities which Philip Morris in the past didn’t have, because they were not needed [technical difficulty] now we have electronics with all the complexity, and some of you I think, have the perspective of this, of what does it mean.
Another thing is that Philip Morris historically was a very B2B business despite the fact that we always called ourselves FMCG, the consumer was served essentially by the trait, right. So the business model is that you’re selling your product to wholesale and retail. And then for marketing, you essentially create the pool and the consumer go and ask for your product at the retail shop, as a part of this transformation we wanted to own the relations with the consumers.
So yes, there was a distribution part of our business, which is selling to wholesalers, retailer. But very important element and which serves us very well, is owning these relations with consumers, which actually accelerates switching from smoking to the cigarette. So we’re essentially going into B2C, not necessary from a transactional perspective, but from the consumer relationship perspective.
And there is a third axis, which is external, and this we include this obviously includes not only investors, but very much also all the regulators, et cetera, which have to now open their mind, and admit that instead of harm elimination, maybe harm reduction is something, which yields much faster and much bigger results.
We have a free product platforms, which I demonstrate, which I show here on the slide, on the left-hand side. Yes, on the left-hand side, you have a heat-not-burn with our flagship IQOS brand. We also involve in e-vapor product, and we have here on the slide, you have one product, nicotine pouches, which is non-tobacco containing product, oral product, oral use product, but we also have Swedish snus product, which is pouch, but with the tobacco.
Two products which we have in our portfolio today have received the highest, you — if I may call it like this, level of recognitions which is FDA authorization under the MRTP process, which if you compare it to any regulatory regimes in the world, I mean, there are no other products which really come to that muster, which means that the FDA’ had enough of the confidence to allow for the marketing authorization of this product, also on the ground of the advancing the public health objectives, which is use this product as a replacement to cigarettes.
We started the first product was launched — in 2014, essentially Philip Morris 100% combustible international company. Fast forward, which was not that fast, but forward at the end of the Q3 last year, 36% of our revenues are coming from this new product, which this was for many of us, this potentially, for me, I guess, was like a great movie, when you thought that it was just 20 minutes and somebody told you that you were sitting for a full weekend in the movie theater. And the time flies fast with the transformation.
However, the most exciting thing is that there is actually more to come from Philip Morris than what we have achieved today, because we have, as I said, a billion smokers very recently, through the acquisition of Swedish Match, we are coming back, if you like, to the U.S. market, which is by far the most sizable and profitable nicotine market, nicotine pouches, especially ZYN is a very good addition to our portfolio, which also will be focusing on growing this internationally.
And we essentially a few quarters away from taking over rights to IQOS from our former parent and start being in charge of bringing heat-not-burn product to the U.S. market. So I can go on and on how many more opportunities in this quest for a smoke-free future is in front of Philip Morris. And I’d rather use that sort of the past statistic as the proof that somehow it looks like we know how to do it. So far so good.
How this product is actually — third question is, how this product actually changing the landscape of a consumption, cigarette consumption on international? So one of the thing which I was trying to demonstrate here is on the green bars, you have international decline rates of cigarettes over the last few years. Obviously, you have these distortions around the COVID period, 2020, 2021, and how the smoke-free products, in this case IQOS, is accelerating decline of smoking.
And it’s very clearly seen, even including the COVID times, that IQOS is accelerating the decline of smoking. It is much more visible if we look at Japan and the reasons why we always very often refer to Japan, because it was the first market in which we started our smoke-free journey in 2014/2015. So you could see here how IQOS, or heat-not-burn products have accelerated dramatically the decline in smoking, in cigarette sales. And obviously what is the penetration of the heat-not-burn products in the U.S.
Now, if I go now from the inhalable products for a second and log into one country in Europe, Sweden, and see what has happened in Sweden, when until the 1980s, somewhere of this period, you had the cigarette sales growing, which is the blue bar and then all of a sudden the attention start being paid to the other forms of consumption of tobacco nicotine the oral [ph] Swedish snus product.
And you could see slowly, but surely growing yellow line, accelerated with innovations et cetera, which happens around the oral products as the replacement to cigarettes. And end of the game is that the Sweden today has presumably the lowest, if not truly the lowest rate of smoking cigarettes in the world, essentially crossed the 6% line of a smoking incidence, they’re approaching 5% and some of you’ve heard me that I said, maybe the place for the cigarettes is in the museum.
Actually, Sweden is walking the talk. Okay, cigarette is the element of the past, and what more importantly it supported by, and there’s a long data, right, I do appreciate because we’re talking a few decades when all of these things happened in Sweden. Sweden today has by far the lowest level of smoking-related diseases among the male in the world. This includes the lung cancer and some heart diseases.
So these products works, yes they do contain nicotine, but we all know that the nicotine is not the main cause of the harm caused by the smoking, it’s all the other toxicants which are released. Yes, nicotine is addictive, but again it’s very important, it’s not the nicotine, which creates this massive harm, which is created by smoking.
I think we can use Sweden, and very often I am asked by the investors, okay, how many years et cetera it will take you to be smoke-free? Look these are difficult questions, because nobody has done it before. But the fact of the life is that the world will go smoke-free is given. And the only thing which we’re now debating is, do we need the 10 years, 50 years or 20 years?
But the destination is given, and I think more countries like Sweden now where there’s so much investment behind the innovation et cetera, is going to demonstrate that something which you know a few decades ago was unachievable, people wouldn’t be able to dream about it, is actually becoming a reality.
In our transformation, it’s also very important that, we track our progress, not only for our internal purposes, but very much also for, the tariff taxes of our transformations of the external audiences. So some of you are very familiar through our Integrated Report and other means, we very regularly update, where do we stand on our transformation metrics?
We have – here is the example, the real example of the business transformation metrics, which number we track, resource allocations if I start with 99 point something, presumably R&D expenditures, is essentially devoted, is entirely devoted to the smoke-free product, we don’t invest in combustible cigarettes at all. Okay. We stopped doing this already some years ago.
Three quarters, almost three quarters of our commercial expenditure is behind the smoke-free products, despite the fact that today they contribute one-third of our top line. So, we can go on and on through all these metrics, how we measure this progress et cetera. But as I said, it’s very important for us that we operate in on the same wavelength, both internally and externally. And that it helps in pursuing this strategy.
Another way of looking at this whole thing, we have spent so much more than almost $11 billion cumulative investment behind R&D, but also CapEx, the manufacturing capacity et cetera 27 – more than 27 million users of IQOS. The best efficacy from all the smoke-free products in a market measured by the fact of how many people will completely stop using cigarettes, IQOS stands in the 72%, which means from the 100 people current smokers who would buy IQOS, 72% will fully, fully, fully switch or stop smoking cigarettes, which from the tobacco harm reduction perspective is the very important component. And our revenues, as I said now at 36% at the end of the last quarter.
Where we want to go? And we always have to put some ambitious, but somehow also attainable directions with objectives for the company. We think that by the end of the decade we should be at about the two-thirds of the revenue coming from smoke-free product, but most importantly is that it has to happen market-by-market. We believe that by the end of the decade more than 40 markets or above the 40 markets will have more than three-quarters of revenue from these products, and another 20 markets substantially above the 50%.
Here comes sustainability, and I should actually start with the slides, but I wanted to give you the context that it is impossible to make the business of our company sustainable, if we don’t go and address the product first. Everything else would be operating under fringes, so we need to go and first do our homework, do our job on the product, which by the way when we go into our sustainability materiality exercise, and in Philip Morris which is known to many companies, in Philip Morris we do what we call the double sustainability assessment.
So actually, we’re assessing our impact on environment and environmental impact on us. And that’s the net result of the size of the circles, of the bulbs is the importance of the thing. No surprise I guess to anybody, is that on top-right counter – in corn where you have a product health impact, and then very quickly followed by climate, and the reason for the climate is that 80% of everything, which we put into our product is somehow connected or dependent on the climate.
Okay, this is agriculture, whether the forest, whether the tobacco growing et cetera. There is one important component that we not talked about is, but quite rightly external work, but also internally, we pay attention to ourselves and marketing practices, you see this in one of the bulbs in the top corner, which is nothing else, that these products are designed truly and only for the adult smokers, i.e. there is no reason — sorry, there is no room for any compromise, that none of this nicotine-containing products should get into the hands of the minors.
Now to structure this whole transformation journey, including the element of sustainability, we have divided our strategies into — we have eight impact driven strategy, if you like, which are divided into two groups. In the core of the slide, you see the four strategies, which relate to the product. And on the outside circle, you see the strategies, which are designed to address our operational impact. And obviously, we have to all work in the context of the government principles, practices et cetera. And this is the outer part of the circle.
Now these strategies are in order to measure or have some measures or milestones midterm, long-term et cetera, translated into 11 goals, which creates our 2025 roadmap. And on the top of this, we have something, which I believe, at least to my knowledge, is very much unique to PMI the index, the KPIs, on which we’re getting measured. And this leads me to how do, we then connect this into the incentive system for employees, but very much obviously for executives, including obviously myself.
So 30% of our performer share units – assessment is based on the sustainability. Within this 30%, we over weighted the product, again knowing that the product is in the core of the sustainability and 10% coming from the operational. So, we have all the framework for the sustainability with clearly defined strategies, milestones where we want to be ’25/2030, how we create some objective system, which allows the Board, shareholders also to see how the investor, sorry, how the management executives are paid.
We’re also using the same assessment platform for our financing. Here is an example in 2021, we published business transformation-linked financing framework, as a result of this we drew a $2.5 billion of the borrowing linked to our transformations KPIs.
Now to the environment strategy, I mentioned that number of times, 80% of our product are coming from the nature and the uniqueness also in case of our company, is that we have almost a direct, if not direct relations with the farmers. So before we even go and start tackling the climate, we need to take care about the day, quality of the living, if you like, right? So you know it’s in our interest that these farmers continue in the business. We have to take care about the living income, we need to take care about the child labors and other practices, which the farmers might have had, but also working at the same time of what we can do in our own operations.
So here is the whole strategy about the climate change, about the decarbonization with the clearly defined milestones on a Scope 1 and 2, which is something when we have most direct impact, but also we’re looking at the Scope 3 what we’re going to do about the preserving the natures in terms of the forest, which are used in the curing of tobacco wood from forest used for the curing of tobacco, but also for the paper materials and so on and so. It’s one component which we also have to address and working on is to reduce the post-consumer waste, and I will talk about this in a second.
So the whole approach, that I could tackle in the climate change, I can summarize, maybe oversimplify slide, but this helps, you know – may help shaping even some conversations inside the company. First, how much we can reduce of the emissions of what we’re doing. How we can change the processes et cetera. How of this reduction of the remaining emissions we can start switching the source of energy to something which has a much less impact on the environment.
But also recognizing that maybe there are things, which we’ll not be able to achieve and therefore we need to think with the open mind about the potential offsetting, maybe also in-setting going forward strategy. So those are the three components, how PMI is essentially addressing or tackling the climate change. Our objectives are very clear. Again they are well-documented, published, shared in our Sustainability Report, Integrated Report. By 2040 we should be carbon neutral on the 1, 2 and 3 Scope. But by 2025, on the – 1 and 2 Scope.
Now I mentioned about this agriculture, et cetera. By 2030 our objective is this essentially we will become — we will have a zero net deforestations in tobacco supply chain, sorry by 2025. But if I add all the paper materials and pulp coming from well at the end from the forest, we should become — we should have a net deforestation impact by 2030.
Now I mentioned about the reduction in the post-consumer waste, it’s very much requires incentive systems, education, whatever on the consumer level. I mean, this is cigarettes buds, which are thrown on the street. Good thing is actually that smoke-free products consumables are by the factor of several X actually less thrown on the streets, because they don’t combust, it’s much easier to dispose of them et cetera. And we have systems in place in some countries already. When we start collecting heat stick butts and the consumer send them in their bags to us, which we can then later on go and not recycle, but reuse them or dispose of them in a responsible way. So, this is responsible manner.
So there is another advantage of smoke-free products versus the cigarettes due to the nature how they operate, gives this opportunity. Very important thing is our investments in electronic devices. So also we recognize that the better we are in the durability of these devices, that’s the first impact which we can have in the post-consumer waste. Remember the first devices of IQOS, which we commercialized and the life cycle of about a year, and today we operate with the devices, which are approaching three year. So, this is the impact, which we can have immediately while working also on the recyclability, reusability of these devices and the package.
I have to summarize one thing as I said it a number of times when I’m just coming to the end of my presentation, I – was always a strong believer of sustainability. And I thought that the key component to make sustainability sustainable is profitability. I don’t create the value, if you don’t create the value from a sustainability that sustainability always will be at the mercy of the budget cuts adjustments, et cetera.
So it’s up to the companies to make sustainability profitable. If you can demonstrate that you can generate value, then by definition your sustainability is sustainable. Otherwise, we almost edging at the exercise of corporate social responsibility, rather than true sustainability, which I think we have demonstrated so far, because as often I tell my investors that if they didn’t know the transformation effort, which Philip Morris went through inside, and you will just look at the performance of the company, you might have not figured it out that, we actually are going or we’re going for the transformation.
This is the example of the dividend. This is where we stand on the total shareholders returns. And that’s the end of my slide, which I can summarize, in other words, for many people, especially when we talk about the transformation, some people may think it is walk in a park, to which I always respond, absolutely yes, but this is a Jurassic Park. Thank you very much.
Question-and-Answer Session
A – Unidentified Company Representative
Thank you, Jacek. A couple of questions, and thank you folks for sending your questions in through Whova. So using the first question, using an energy analogy, would you describe your business transformation as one of moving to renewables?
Jacek Olczak
You could draw some parallels like this as well. If you want to reduce impact of energy on the climate, on the climate environment et cetera, obviously, the less energy – if we stop using energy, we will address the other things, but we don’t want to do it for obvious reasons. So the whole question is, can you use the energy smarter? Can you use it less? Can you have more efficiency et cetera?
Harm reduction, actually, I know that very often, especially in Philip Morris language, we talk about the tobacco harm reduction, but harm reduction is a well-known concept which was actually driving, I could argue, the growth of a civilization, because we always were aiming and reducing the negativity, the negative impacts of whatever it was, process, product, et cetera, while preserving, if you like, the positive aspects of this comfort [ph]. So, yes, one could draw that parallel.
Unidentified Company Representative
Thank you. Another question. And I believe this is from a smoker. And they are asking the question thinking about how tobacco could use their product to make bioenergy. So, the question is, could we use that cropland that you were talking about for sustainable aviation fuel source material?
Jacek Olczak
I wouldn’t then use the tobacco, if tobacco has reached [ph], there are presumably other crops which would be more — better designed for that purpose. We could think about using the — I mentioned the program about collecting the consumables from the smokers, from the users of IQOS in this case. And we could think about that, this has a high energetic value. We could think about uses of this. But I wouldn’t just go for the tobacco crop.
We are having programs in place, because obviously these new products require less tobacco material than the conventional combustible cigarettes. Now the programs which we’re running are more focused on encouraging tobacco growers to produce the food in central proportions of the tobacco. But this also helps managing or improving the living income of the farmers. So we rather go in these directions rather than grow the tobacco for the energy purposes.
Unidentified Company Representative
Regulation is top of mind for a lot of us here in the U.S., and obviously in Europe, of course, how is Philip Morris preparing to respond to upcoming regulation mandating non-financial disclosures?
Jacek Olczak
Well, I may not sound very humble now, but actually I start seeing returns that we early invested into creating the whole sustainability framework, including its monitoring and reporting system. I’m not saying that what Philip Morris has today, if I use as a proxy Philip Morris Integrated Report, et cetera, it presumably will require a couple of adjustments et cetera.
But internally, we have pretty good process over how you collect, process, et cetera, information. So, we were not surprised that the non-financial disclosure regulations U.S., but also Europe, very much welcome. And I believe we are obviously not 100% done, but I feel much more comfortable when I see these deadlines coming that we can manage this rather than imagine, I would have to start from the scratch.
So the effort, which we have done over the last few years actually save us a lot of time and the pressure going forward. But actually, I think all these regulations also needed, because you know it very well, we have not agreed on the definitions, on the methods of measurement, et cetera. It creates a lot of confusion, not only internally, but also I guess for the investors as well. So some degree of — yes, of some regulatory interventions are needed on something, which I guess is important to all of us.
Unidentified Company Representative
And we have one last question. Japan, you’ve seen a lot of movement and have cataloged success there. Can you talk a little bit about key learnings from there, from consumer, regulatory and health impact perspective?
Jacek Olczak
Yes, so I said something which came as the surprise to us at Philip Morris as well. So initially, we thought when we go to the consumer smoker, people who smoke, and I tell them, hi, we have a product which reduces exposure by 90%, 95%, or 99%, people will jump from their bed and run and switch. And the smokers told us, yes, but we love smoke, which actually made the case even harder, because if we don’t aligned regulatory interventions with the product innovations, this billion smokers is, actually much real number than one could think.
And when I say that, I’m saying this as an Executive of a Tobacco company, people love — sorry smokers love smoking. And therefore the bar is very high, put on the companies like ours if we want to convert them or switch them to the better alternatives. We can do a lot ourselves, and I demonstrated what this PMI has done. But I think there is a big role for the regulators like FDA and the similars to realize one fact that by shouting and shaming smokers more, nothing will change. So, now can we change the strategy and do something, because otherwise billion people will have no option.
Jacek Olczak
Thank you. Thank you for the presentation. And really an update on transformation, we had heard from Andre right before COVID hit, and a plan, and people, are they really going to stick with it? They made these commitments. And you can see the progress that the group has made. At this point, we’re bringing up what could be as I told them earlier…
[Abrupt End]
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