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EDITED TRANSCRIPT

SWMA.ST - Q3 2021 Swedish Match AB Earnings Call

EVENT DATE/TIME: OCTOBER 27, 2021 / 11:00AM GMT

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OCTOBER 27, 2021 / 11:00AM, SWMA.ST - Q3 2021 Swedish Match AB Earnings Call

C O R P O R A T E P A R T I C I P A N T S

Anders Larsson Swedish Match AB (publ) - CFO & Senior VP of Group Finance

Emmett Harrison Swedish Match AB (publ) - SVP of IR & Corporate Sustainability

Lars Dahlgren Swedish Match AB (publ) - President & CEO

C O N F E R E N C E C A L L P A R T I C I P A N T S

Fredrik Ivarsson ABG Sundal Collier Holding ASA, Research Division - Research Analyst

Gaurav Jain Barclays Bank PLC, Research Division - Research Analyst

Jared T. Dinges JPMorgan Chase & Co, Research Division - Analyst

Mirza Faham Ali Baig Crédit Suisse AG, Research Division - Research Analyst

Richard Felton Goldman Sachs Group, Inc., Research Division - Equity Analyst

P R E S E N T A T I O N

Operator

Welcome to the Swedish Match Q3 Report 2021. (Operator Instructions)

I am pleased to present Emmett Harrison, Senior Vice President, Investor Relations. Please go ahead with your meeting.

Emmett Harrison - Swedish Match AB (publ) - SVP of IR & Corporate Sustainability

Good afternoon. This is Emmett Harrison, Senior Vice President of Investor Relations at Swedish Match. And joining me today is Lars Dahlgren, our CEO; and Anders Larsson, our CFO.

Lars Dahlgren - Swedish Match AB (publ) - President & CEO

In the Investors section of our swedishmatch.com website, you will find our Q3 investor presentation. We encourage you to have that presentation at hand as you listen to our prepared commentary for this call. Several of the slides in the investor presentation repeat key messages from the interim report that we published this morning. We will focus our commentary on select slides only. And while doing so, we would refer to the applicable page number of the presentation.

After our prepared commentary, we will be taking questions. During today's call, there may be certain comments that constitute forward-looking statements and are subject to risks and uncertainties. Management believes that these statements are based on reasonable assumptions, but can give no assurance that expectations will be achieved. Risk factors are outlined in today's interim report as well as in the annual report, which are available on our website. Swedish Match assumes no obligation to update information concerning its expectations. A recording of this call will be made available on the Swedish Match website.

After that intro, that was mostly read by Lars, because we are in different locations, so apologies for the technical difficulties. But I will now go on with the main commentary.

In today's report for the third quarter, we reported record sales with year-on-year revenue growth across all product segments. Operating profit from product segments was also at record level and considering well-executed ramps up in marketing and selling activities, the more elevated demand for some of the product lines, along with lower-than-normal administrative and selling expenses in Q3 of the prior year, the year-on-year profit growth reported to date is a testimony to both the strength and the potential of our businesses.

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OCTOBER 27, 2021 / 11:00AM, SWMA.ST - Q3 2021 Swedish Match AB Earnings Call

The Smokefree product segment represents more than 70% of our group EBIT. And with nicotine patches becoming a larger and larger portion of our product portfolios across markets, the growth prospects of the Smokefree segment are becoming increasingly attractive. For the 9-month period ending September 30, revenues attributable to nicotine pouches were approaching 40% of the sales of the entire Smokefree segment.

Without the exception in our core geographies being Scandinavia and the U.S., the consumption of nicotine pouches continue to exhibit strong double-digit growth in the third quarter. Also, in several of the other markets where we are present, we see similar trends. In the U.S., more and more adult tobacco consumers are discovering the benefits of nicotine pouches over their current form of tobacco use. And in Scandinavia, nicotine pouches are enhancing the already attractive dynamics of the Smokefree category by making the product more relevant for broader consumer groups, not the least women.

In the U.S., ZYN continued to perform very well in the quarter. Despite aggressive and deeper promotions from large competitors, ZYN demonstrated market share resilience and grow its shipments sequentially relative to the second quarter by 7% on a constant trading day basis. Higher velocities measured on a can per store week basis within our existing store distribution footprint continue to be the key driver of growth.

As indicated in the second quarter conference call, we outlined an ambitious plan of activities for Q3 geared toward driving awareness, engagement and loyalty for ZYN with both consumers and the trade. I'm very pleased to note that we successfully executed on this plan and we were pleased with our volume development and market share resilient.

Traditional smokefree product in the U.S., however, had a weaker development in the third quarter, to a large extent, due to comparison with elevated demand in the prior year. Our Smokefree business in Scandinavia continued to report strong top line development, along with earnings growth, in spite of significantly higher spending in pursuit of growth opportunities within nicotine pouches also on this side of the advantage.

With very strong category development, snus shipment volumes grew at a respectable rate despite our portfolio skewed towards a slower growing snus market and shipment growth for nicotine porches that fell somewhat short with the market growth rates. Strong realized pricing contributed meaningfully to the sales development, resulting from price increases, product and segment mix effects as well as continued high deliveries to Norway, where there is virtually no low price segments.

For U.S. cigars, we pointed to likely elevated demand brought on by the COVID-19 situation in the prior year quarter. Demand from consumers and the trade has remained strong. And since the onset of COVID, manufacturers have struggled to produce enough cigars to satisfy demand. Our own supply chain organization has made impressive progress in managing a difficult situation and raising productivity for natural leaf varieties, shortage of certain raw materials brought on new challenges in Q3, which especially affected shipment volumes of HTL varieties.

Given difficult comps in Q3 of the prior year and the strained supply chain situation, I would characterize our cigar business' performance during the quarter as an accomplishment. An achievement to highlight is record shipment volumes for natural leaf cigars and resulting share gains with this strategically important segment, both versus the prior year period and sequentially compared to the second quarter.

Over the past 10 years, the natural leaf segment has grown at an annually compounded rate in excess of 20%. And for the year-to-date period, more than 60% of the Swedish Match cigar shipment volumes were comprised of natural leaf cigars.

The successful strategy of focus on the natural leaf segment, the strong track record of innovation and nurturing of leading brands like Game, Garcia y Vega 1882 and White Owl position Swedish Match's cigar business very well for growth.

The cigar business has now grown to a scale where we believe that the advantages to the business of pursuing a separate autonomous strategic agenda would outweigh any negative impacts from the loss of synergies or scale economies present under the current setup. This is the key reason why we, on September 14, announced our intention to carve out the U.S. cigar business into its own independent company and to list the new cigar entity on a U.S. Stock Exchange via a spinoff through its shareholders.

The remainder of Swedish Match U.S. business has had an even more impressive historical track record of growth in recent years. And the current scale of that business implies that the administrative and other dis-synergies that would result from a cigar spinoff are manageable. While some

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OCTOBER 27, 2021 / 11:00AM, SWMA.ST - Q3 2021 Swedish Match AB Earnings Call

resources are anticipated to transfer to the new cigar company in conjunction with the intended spinoff, the intention is that the new cigar company will establish a more streamlined and fit-for-purpose sales and administrative structure.

What this means for the remainder of Swedish Match in the U.S. is that even more resources would be available to focus on expanding and executing on the smokefree growth strategy with the ability to reach full dedication, crystallize both the significant harm reduction and commercial opportunities of that business in line with our vision of a world without cigarettes.

Following these introductory remarks, we will now provide some more comments to select slides of our Q3 investor presentation. And starting on Slide 8. Slide 8 illustrates the impressive trajectory for ZYN shipment volumes in the U.S. on a 12-month rolling basis. During the third quarter, we delivered record volumes of 46.2 million cans, which brought the 12-month rolling shipment volume to close to 160 million cans. For the year-to-date period ending September 30, ZYN shipment volumes in the U.S. grew by more than 50% compared to the corresponding period in the prior year, with continued strong growth in the Western region, where we initially launched the product and also in the other regions outside of the West, where we started building presence at a more meaningful scale from the spring of 2019.

Slide 9 illustrates the volume development for all nicotine pouch brands in the U.S. as measured by MSA data. As we have pointed out before, MSA data is particularly helpful in analyzing trends over a longer period of time, while isolated quarters can be susceptible to ways for distribution expansion and promotional offerings, et cetera, that cause retailers to stock up. Yield over several quarters, however, the chart depicts the impressive growth trajectory of the nicotine pouch segment, which we now estimate to have reached the size of about 280 million cans on an annualized basis based on the current run rate.

The dotted line in the chart illustrates the resilience in ZYN market share over the past quarters, and we are very encouraged to note that ZYN has held up its position very well despite continued broad-based and deep promotional activities from major competitors. During the quarter, there were also certain summer promotions for ZYN that calibrated to well aligned with the premium profile of the brand, which implied a promoted discount for can at retail level well below rebates typically seen from major competitors.

Slide 10 provides some more details of the trajectory for ZYN based on the same MSA data. Starting with the graph to the left, which shows the number of stores selling ZYN with historical 13- and 26-week period, you will note that the store count for ZYN has increased in a controlled manner. Currently, the number of stores selling ZYN is around 100. To the right-hand side of the slide, you can see the consistent growth in velocity for ZYN on a quarterly basis.

In the second quarter, the velocity for ZYN benefited somewhat from the sell-in of Menthol and Chill varieties at the national level, while this year, summer promotion had a favorable impact in the third quarter. Again, we urge you to take a longer-term perspective. And if you compare to the third quarter 1-year ago, the number of stores have grown by 13%. As a testimony to the appeal of the ZYN franchise, the velocity has grown by an impressive 27%.

Turning to Slide 11. Based on recently conducted consumer research, we have updated some of our benchmarks for the nicotine pouch segment in the U.S. On this slide, we look at benchmarks for our estimated number of ZYN consumers rather than consumers of any brand of nicotine pouches, bearing in mind that ZYN enjoys a market share well above 70% in the West.

Our most recent estimate indicates that the number of ZYN consumers in the West now makes up more than 10% when compared to the number of cigarette smokers. The corresponding number nationally has grown to close to 5%. These benchmarks not only demonstrate the high level of acceptance that ZYN has among consumers, but more importantly, they highlight and reinforce the future growth potential for ZYN, including its great harm reduction potential.

When comparing the trajectory for velocity growth for nicotine pouches in the expansion markets versus the West, the velocity development in the expansion markets up to this point shows a similar growth rate, but at slightly higher levels compared to what was noted for the West region based on a comparable number of months in the market. It should also be noted that in addition to cigarette smokers, adult users of other forms of tobacco such as moist snuff and obsolete ENDS have proven to be an important source of users for ZYN.

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OCTOBER 27, 2021 / 11:00AM, SWMA.ST - Q3 2021 Swedish Match AB Earnings Call

In addition, one needs to remember that across the entire user base, estimated average consumption for nicotine pouches are still relatively low, in and around 2 cans per week. This can be compared to reported consumption patterns for consumers registered in the ZYN loyalty program now were in excess of 100,000 consumers, whose average consumption is about twice that number, which is largely consistent with consumption patterns reported for U.S. moist snuff consumers and Scandinavian snus users.

The combination of consumer migration rates from other tobacco and nicotine categories, coupled with likely increased weekly consumption levels, bode extremely well for the future growth prospects of the nickel pouch segment and its market-leading brand, ZYN.

With that, I will give the word over to Anders.

Anders Larsson - Swedish Match AB (publ) - CFO & Senior VP of Group Finance

Thank you, Lars. Moving on to Slide 12 and the Scandinavian Smokefree category. The strong volume trend for Smokefree products in Scandinavia continued in the third quarter, supported by solid consumption growth in all the 3 Scandinavian countries: Sweden; Norway; and Denmark. Swedish Match's best estimate is that the overall Scandinavian smokefree market grew by close to 10% year-to-date in volume terms. While nicotine pouches were the key source of growth, snus also contributed with low single-digit growth for the combined Swedish and Norwegian markets.

Slide 13, which depicts the volume trajectory for the Scandinavian Smokefree category on a 12-month rolling basis based on Nielsen and online sales data, clearly demonstrates the acceleration of growth resulting on the broader consumer adoption of nicotine pouches. More than half of the nicotine pouch user base is comprised of women and cigarette consumption historically has been higher for women. We view this as a very positive development from both a harm reduction and a commercial perspective.

A word of caution is warranted when viewing the acceleration of growth that this slide indicates in and around the onset of COVID, with travel restrictions and changes in consumer purchase pattern, the data is susceptible to differences in data coverage between different classes of trade.

In our estimate of close to 10% overall category growth, for the year-to-date period, we have adjusted for this, but it remains a challenge to estimate consumption data with precision. While the margin of error should be applied to the overall estimate, the data indicates that the sharp reduction of retail prices in Norway following the excise tax reduction in January of this year has fueled consumption growth further.

On Page 14, we look at market share development in the Scandinavian snus market as reported by Nielsen. Our share for snus in Scandinavia has been stable over the past few years, and we remain the clear market leader, more than twice the size of the next largest competitor. While the declining percentage of snus relative to the entire Smokefree category is apparent as illustrated to the right on the slide, this needs to be considered in light of very strong overall category growth.

Further, with the low-price snus segment in Sweden that has remained relatively stable and almost an absence of low-priced products in the growing Norwegian snus market, the premium segment share of the overall Scandinavia snus market has grown slightly.

On the following slide, Page 15, we look at share trends for the nicotine pouch market in Scandinavia using Nielsen data. The competitive intensity of the nicotine pouch market has escalated even further during the third quarter with a high level of activity, both in terms of new brands and varieties and in terms of promotional offerings, both online and in traditional retail channels. The high activity level has supported growth of the category, which now represents close to 22% of the Scandinavian smokefree category according to needs and data.

As illustrated in the graph to the left, Swedish Match's nicotine pouch volumes continue to grow strongly in the third quarter to some extent aided by VOLT launched during the second quarter. With a competitor of ours having what can be described as a first-mover advantage, the proliferation of product and brand offerings available to consumers and the intensity of competitive activity generally improving our share of the Scandinavian nicotine pouch market remains a challenge that takes time to address. However, with the pipeline of distinctly differentiated innovations showing very promising test results on several key parameters, we remain confident that our unique capabilities will make a difference.

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Swedish Match AB published this content on 27 October 2021 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 29 October 2021 11:10:06 UTC.