Philip Morris International - Q1 2024

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the Philip Morris International 2024 First Quarter Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, James Bushnell, Vice President of Investor Relations. Please go ahead.

James Bushnell (VP of Investor Relations)

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2024 first quarter results. The press release is available on our website at pmi.com. A glossary of terms, including the definition for smoke-free products, as well as adjustments, other calculations, and reconciliations to the most directly comparable US GAAP measures for non-GAAP financial measures cited in this presentation, are available in Exhibit 99.2 to the company's Form 8-K, dated April 23rd, 2024, and on our investor relations website. Today's remarks contain forward-looking statements and projections of future results. I direct your attention to the forward-looking and cautionary statements disclosure in today's presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements.

I'm joined today by Emmanuel Babeau, Chief Financial Officer, and Jennifer Motles, Chief Sustainability Officer. Over to you, Emmanuel.

Emmanuel Babeau (CFO)

Thank you, James, and welcome, everyone. In Q1, we delivered outstanding performance that exceeded our expectations, with double-digit growth in organic net revenue and operating income, as well as currency-neutral adjusted diluted earnings per share, all supported by robust volume growth. Excellent smoke-free business momentum continues, with +25% organic growth in net revenues and +38% in gross profit as IQOS operating leverage and VEEV mix contribute positively. IQOS continues to advance rapidly, with growth of +13% in adjusted in-market sales volumes and +21% in shipments. IQOS ILUMA is a key driver of this progress and is now available in 64 markets, representing nearly 100% of IQOS volumes outside Russia. ZYN also continued its considerable growth in Q1, with U.S. volumes up +80%.

Importantly, this top-line performance translated into strong operating income growth and margin expansion, both organically and in dollar terms. This was notably driven by accelerating profitability in both our IQOS and ZYN businesses, in addition to improving combustible performance. We faced higher than expected currency headwinds in the quarter, primarily due to the devaluation of the Egyptian pound. We are taking mitigating actions, including additional pricing and accelerated cost initiatives, which allowed us to deliver Q1 adjusted diluted EPS above our prior expectation despite these pressures. While the prior year quarter was favorable for certain growth comparison, this exceptional start to the year set the stage for us to deliver significantly better than expected 2024 currency neutral growth and robust growth in US dollar at prevailing rates. Turning to the headline numbers.

Very good shipment volume growth of +3.6% supported organic top-line growth of +11% or +8.6%, including currency. This reflect continued excellent IQOS and ZYN momentum, as well as strong combustible pricing. Operating income grew by +22.2% organically versus a softer prior year quarter, notably driven by gross margin expansion and a deceleration in SG&A growth. As a result, our organic OI margin expanded by +3.7 percentage points. In dollar terms, adjusted OI grew by +11.3%, and adjusted OI margin expanded by 90 basis points. We outperformed our Q1 adjusted EPS outlook due to three main factors.

The first is the net revenue and profit impact of better volumes following the industry-leading performance of ZYN, the strong shipment growth of IQOS HTUs, including some higher than expected timing benefit, and a resilient combustible delivery. Second, is the benefit of our pricing action to mitigate currency headwinds, and third, is on cost, including some timing benefit and a step-up focus on manufacturing and back-office efficiencies to prioritize growth investments. The majority of the outperformance was driven by underlying business dynamic, which bodes well for the remainder of the year. Indeed, we delivered adjusted diluted earnings per share of $1.50, representing +23.2% growth, excluding an unfavorable currency impact of $0.20. This includes $0.9 from the devaluation of the Egyptian pounds, including a transactional impact of $0.6, primarily related to the balance sheet remeasurement of foreign currency payable.

With increased liquidity in the Egyptian pounds, we are now reducing our balance sheet exposure, and this should be complete in the coming weeks. Focusing now on volumes, our Q1 HTU shipments of 33.1 billion units exceeded our outlook with robust underlying growth across geographies and a higher-than-anticipated timing impact of shipment to Japan. This, the incremental phasing impact was around one billion unit and was primarily related to Red Sea disruption. While uncertain, we assume this will normalize in the second half of the year. As mentioned previously, we believe the best indicator of underlying HTU growth is adjusted in-market sales as the closest metric to consumer offtake. Adjusted IMS volume grew nicely by +12.5%, including the expected impact from the characterizing flavor ban in Europe.

We continue to see strong IQOS momentum, with excellent growth in Japan, robust underlying fundamentals in Europe, and a growing contribution from newer markets such as Indonesia. We continue to target +14% to +16% adjusted IMS growth for the year, with around +10% growth in Q2, followed by an H2 acceleration, driven by the timing of commercial programs, ILUMA offtake, newer market, and a less demanding prior year comparison. Total smoke-free volume growth of +22% includes the impressive expansion of our oral smoke-free portfolio, powered by ZYN, with pouch equivalent shipment volumes up by +35.8%. US ZYN shipments grew by +80% to 132 million cans. Cigarette shipments declined by a modest 0.4% in the first quarter, with a notable positive contribution from Turkey as we increase share in a strong overall market.

Let me now walk through the drivers of our Q1 net revenues. As I mentioned, volume grew by a remarkable +3.6%, including oral. Pricing contributed +5.5 points of growth, primarily from combustible, as well as pricing of around +3% on HTUs. Smoke-free category mix added +3.1 percentage point to the top line, reflecting the higher net revenue per unit of IQOS, and to an even greater extent, ZYN. Oral smoke-free product overall boosted our organic net revenue growth by +2.2 points, showcasing its role as a meaningful accelerator. To report a positive contribution from our VEEV e-vapor business, which, while still small in the context of the group, delivered good revenue growth.

In 2023, there was a negative geographic mix within our combustible business, where margin market, often without smoke-free product, grew faster, and smoke-free product accelerated cigarette decline elsewhere. Positive category mix impact of smoke-free product and pricing are the three enduring engines for our transformation and growth. Focusing now on the key dynamic of our Q1 profit delivery, smoke-free gross profit grew by an impressive +38% organically, on top line growth of +25%. This reflects the very strong performance of US ZYN and the growth and scale effect of IQOS, including manufacturing productivity. This strong underlying acceleration was amplified by only a few percentage points due to HTU shipment phasing.

Gross margin expanded substantially for both heat-not-burn and oral nicotine, and by a striking +600 basis points organically for smoke-free overall, which made up close to 39% of total gross profit, an increase of +6 percentage points versus prior year. Combustible organic gross profit growth was notably improved and exceeded our expectation at +2.3%. Gross margins were also better than anticipated, leading to an improved full year outlook. Resilient volumes, strong pricing, and manufacturing productivities more than offset the continued cost pressure in the category, geographic mix, and the impact of IQOS cannibalization. As previously flagged, cost increases in leaf, wages, and certain other inputs carried over into 2024, and this should ease next year.

We were also impacted by around $30 million of cost from implementation of the EU Single-Use Plastic Directive, primarily on cigarettes. A key feature of Q1 was strong operating income margin expansion. Gross margin increased organically by 150 basis points, and by 80 basis points, including currency. This reflects excellent expansion within smoke-free product, their growing weight within our business at higher margin, and the better-than-expected evolution of combustible. These factors, combined with productivity savings, significantly outweighed the unfavorable technical dilutive impact of third-party manufacturing in Indonesia, which equated to 30 basis points in the quarter. For SG&A costs, currency neutral growth of only +1.4 drove +220 basis points of organic margin expansion.

This benefited from our resource allocation and prioritization programs, including the delivery of approximately $160 million in gross cost efficiency across COGS and SG&A, towards our $2 billion target for 2024-2026. Although the Q1 margin impact of SG&A cost evolution, including currency, was small, due notably to Egyptian pound transactional currency, we continue to target SG&A progression below top line growth for the year. We expect higher organic SG&A increases in the remainder of 2024, notably reflecting investment spend phasing, which was favorable in Q1. Combination of these factors powered a remarkable +370 basis point expansion in our organic operating income margin, and +90 basis point, including currency. This exceeded our expectation, and we are now raising our full year operating income growth outlook, as I will come back to.

Taking another lens on adjusted operating income margin by geography, we see broad-based global momentum with all regions delivering strong organic progress. In dollar terms, margin expanded in every region except South and Southeast Asia, CIS, and Middle East Africa region, mainly reflecting the transactional currency impact of the Egyptian pound and the technical dilution in Indonesia. Seeing these factors, this region grew margin at a very similar rate to the group. To IQOS. With ILUMA now widely launched, PMI HTUs continue to strengthen their position as the second-largest nicotine brand in markets where IQOS is present. PMI HTUs now exceed the 10% market share milestone on the prior basis, excluding Indonesia, which we now include following broader commercialization in the market. Our HTUs are the number one nicotine brand in 11 markets, and as shown at CAGNY, IQOS net revenues have surpassed those of Marlboro.

Focusing on IQOS in Europe, Q1 HTU share increased by +0.9 points, also crossing the 10% regional share milestone for the first time. While still early in many markets, the growing availability and uptake of ILUMA is a key driver, and we are seeing a strong acceleration in a number of historically slower growth markets. Adjusted IMS volumes continued to exhibit robust sequential growth and reached a record high of 12.6 billion units on a 4-quarter moving average. This reflects year-on-year progression of +9.4% in Q1, with excellent growth in Greece, Portugal, Germany, Spain, U.K., and the Netherlands. Growth was slower in certain central European markets, such as Poland and Czech Republic, where increased economic pressure and price sensitivity are visible. We continue to evolve our portfolio in this market under the recently launched ILUMA system to drive further growth.

Excluding Ukraine, where growth was absent, adjusted in-market sales grew double-digit. As anticipated, the 11 markets so far affected by EU characterizing flavor restriction saw an impact in line with our total region estimate of around two billion sticks for the year. Consistent with similar past situation, we observe an initial consumer adjustment, followed by a reversion of growth rates to previous levels. We have not seen meaningful shifts toward e-vapor or competitor heat-not-burn product, and we expect the structural growth of IQOS to fuel continued HTU progression over the rest of the year. The strong fundamental progress in the region is highlighted by the expansion in key city off-take shares. Very strong gains in cities with already high IQOS adoptions, such as Lisbon, Rome, Athens, and Budapest, demonstrate the potential for further growth at the national level. Recent acceleration in London, Madrid, Munich.

Amsterdam is also very promising for the IQOS brand in this market and for Europe overall. In Japan, the adjusted total tobacco share for our HTU brand increased by an excellent +3.1 points to 29.3%. Adjusted IMS volumes increased by +13%, maintaining the rapid progress of recent quarters. Such impressive growth in a market with already high category penetration is a clear testament to the sustainable growth potential of IQOS around the world. In connection with IQOS' strong brand equity and commercial footprint, we are fostering growth through continued innovation on both devices and consumable. In March, we launched the latest IQOS device, IQOS ILUMA i, in direct channels with national expansion ongoing. We remain laser-focused on innovation. Our innovation in consumables has included a number of new variants and test experiences on the premium TEREA brand.

As shown by the off-take data on this chart, this has helped TEREA to continue growing Japan's share at the same time as mainstream price tier. This successful strategy of broadening consumer appeal with different price tiers, while reinforcing and growing the premium lineup, is a good illustration of how our IQOS business is evolving across market as the category continues to grow. The potential of the category is clearly demonstrated by the performance in Tokyo. As shared at CAGNY, heat-not-burn category volume surpassed combustible in January and have continued to grow since then. Led by Japan and Korea, the East Asia and Australia region reached almost two-thirds smoke-free net revenue in Q1. While somewhat flattered by shipment timing, this clearly demonstrate the path forward for the broader company as we strive towards our ambition of becoming substantially smoke-free, surpassing 2/3 by 2030.

Outside of Japan and Europe, we continue to see very promising IQOS growth across the globe, including low and middle-income market, as highlighted by Key City off-take shares. A notable call-out is Indonesia, where we have expanded commercialization to targeted areas in new city and introduced TEREA closed variants, catering to category taste preferences. We have witnessed an uplift in user growth and now have over 150,000 estimated IQOS users in the country. Our city off-take share in urban Jakarta is one indicator of this, with +1.6 percentage point growth to 3.4% in a growing total industry. We are also pleased to report the re-acceleration of IQOS growth in South Korea following the introduction of ILUMA.

TEREA recently became the number one HTU brand, as measured by national system off-take, and in Seoul, IQOS market share grew by 1.8 points to 12.8%. Egypt continued to stand out with Cairo off-take share up +1.3 points to 9.1%, despite recent pricing, and we also see promising results in Malaysia, Morocco, Lebanon, and the Balkans. While not shown on this slide, Saudi Arabia also had a promising restart, with Q1 national off-take share of 1.3%, following the resumption of IQOS commercialization in late 2023. In a similar vein to some of our European markets, the November launch of ILUMA in Canada has coincided with an acceleration in key city growth, as shown here by Toronto. While still early days for ILUMA and in a very restrictive regulatory environment, this is clearly a positive development.

Moving now to ZYN, where excellent U.S. progress continues in Q1, with +70% sequential growth in 12-month rolling shipments. Impressively, category volume share grew for the fourth consecutive quarter to 74.3%, an increase of +6.9 points year-on-year and +1.3 points sequentially, despite a $0.15 per can price increase in March. Retail value share also grew to 79.3%, highlighting ZYN's premium positioning and superior brand equity. This accelerated growth again reflect a broad step up in nationwide store velocities and gradual distribution expansion as the category gains strong traction with adult nicotine users. As outlined at CAGNY, we remain focused on marketing ZYN responsibly to prevent unintended use. We support the FDA's effort to ensure only consumer over 21 have access to nicotine product.

Swedish Match follows a robust U.S. marketing code that prohibits using social media influencer, educates digital platform to 21+, and includes partnering with We Card to help ensure retail sales only to legal age adults. I'd like to spend a moment now on combustibles, where our portfolio delivered robust organic net revenue growth of +3.7% in Q1. This primarily reflects better than expected pricing of +7.9%, with a notable contribution from Germany and stepped-up pricing in Egypt. The pricing environment remains favorable, and we now forecast a full year increase of +6% to +7%, with annualization effect lessening in H2.

Our cigarette category share grew by +0.3 points in Q1, and this includes positive contribution from Algeria, Poland, and Turkey, resulting in only a modest volume decline in a total cigarette industry, which fell by 0.6%. Our global brands gained category share during the quarter, with Marlboro gaining +0.4 points. As previously flagged, our 2023 share of segment was flattered by competitor supply constraint in Egypt, which may normalize this year. As I already mentioned, strong pricing in Q1, coupled with accelerated manufacturing productivity, also resulted in a better than expected margin evolution. Now, let me provide an update on our latest innovation and expansion plans as we further accelerate our smoke-free transformation. As I covered earlier, we recently launched IQOS ILUMA i, our most innovative offering to date in Japan.

The ILUMA I portfolio consists of three devices, offering a range of adaptable new features. This includes a new touch screen on the device holder, which allows users to see experience relevant information quickly and easily, as well as a pause mode, so user can pause and resume their smoke-free moment where they left off. Initial consumer feedback has been very positive. Japan was the first market to launch ILUMA in H2 2021, and we plan to gradually roll out ILUMA I to more geographies over time. As shown in our Japan and Indonesia performance, consumable innovation on the ILUMA platform is also critical as we broaden offering across markets. LEVIA HTUs, which contain nicotine but no tobacco leaf, were launched nationwide in the Czech Republic and Romania in Q1, with promising initial results. More markets are planned later this year.

DELIA, our new mainstream price brand for HTUs, was rolled out in Switzerland, Hungary and Lithuania. In the U.S., we continue to prepare for the first consumer pilot in select cities with the IQOS 3 system. As mentioned previously, the commercialization will be initially limited in scope and will be focused on direct activation of select legal-age nicotine user in a few cities, allowing us to experiment with different elements of the commercial model. The main purpose of this consumer activation is to fine-tune our approach in anticipation of the at-scale launch of IQOS ILUMA, following authorization from the FDA. The international expansion of nicotine pouches remain a key focus, notably for ZYN, as the world's leading brand. We have launched or relaunched in 11 markets so far, with more planned later this year. In e-vapor, our focused strategy for VEEV is showing very good early results.

Positive consumer feedback is translating into promising repeat purchase and conversion rate, and we are on the path to profitability in H2. This brings me to our outlook for 2024. With unparalleled smoke-free volume momentum, best-in-class pricing, and expanding margin, we are raising our full-year currency neutral growth forecast. This strong pricing, combined with positive smoke-free mix and efficient cost allocation, also helps us to mitigate currency headwinds and should allow us, at prevailing rates, to deliver on our objective of robust growth in dollar terms. Given continued ZYN volume progress, we are increasing our U.S. shipment forecast to around 560 million cans. We have further accelerated our capacity expansion plans to support this additional step-up.

We continue to target strong growth in both adjusted IMS and shipments of IQOS HTUs, and to reach close to $15 billion in 2024 smoke-free net revenue at prevailing exchange rate. Factoring the increase in shipment forecast and a strong pricing outlook on both combustible and smoke-free product, we are increasing our organic net revenue growth forecast to +7% to +8.5%. In addition to higher revenue growth, we expect accelerated organic margin expansion. This is strongly driven by a significant expected uplift in our smoke-free gross margin due to IQOS scale effect, ZYN mix, and accelerated manufacturing productivities. It also includes organic gross margin expansion in combustible, where we had previously assumed a negative development. In addition, we are focused on delivering further SG&A efficiency while continuing to invest in smoke-free growth.

As a result, we are raising our organic operating income growth forecast to +10%-+12%. Accordingly, we are raising our forecast currency neutral Adjusted Diluted EPS growth to +9%-+11%. This translates into an Adjusted Diluted EPS range of $6.19-$6.31, including an unfavorable currency impact of $0.36 at prevailing rate. The increased forecast headwind is primarily explained by the devaluation of the Egyptian pound and recent weakness in the Japanese yen. As I mentioned, we are taking proactive actions to mitigate the incremental impact. We expect full year growth and operating income margin expansion in both organic and dollar term at prevailing exchange rate. This includes organic expansion in both H1 and H2.

After the excellent Q1 performance, we expect a strong H1 overall, with organic net revenue and OI growth around the high end of our full year ranges. For Q2, specifically, we assume HTU shipment volume of 34 billion-35 billion, and continued strong volume growth for ZYN. We forecast currency neutral adjusted diluted EPS of $1.50-$1.55, including an unfavorable currency variances of $0.14 at prevailing rates. With regard to our balance sheet, deleveragings remain a key priority. We continue to target a 0.3-0.5x improvement in our net debt to adjusted EBITDA ratio in 2024, driven by profit growth and strong cash flow generation. We also continue to target reaching around 2x by the end of 2026, and we'll consider buybacks once confirmed we are on track.

Switching gear, as this quarter coincides with the publication of our 2023 integrated report, I would like to welcome Jennifer Motles, PMI Chief Sustainability Officer, to share an update on our sustainability progress. Jennifer, over to you.

Jennifer Motles (Chief Sustainability Officer)

Thank you, Emmanuel. I'm very pleased to be joining today's earnings call. As Emmanuel mentioned, our sustainability, transformation, and business strategies are one and the same. We're focused on creating value for the long term, where generating shareholder returns requires us to deliver on transformation, and delivering on transformation requires us to deliver on sustainability. As shown in our recent results, our product transformation fosters profitable growth and short, medium, and long-term value creation. However, our transformation also means reshaping both our value chain and how we engage with society. As we venture into new product categories, we actively collaborate with different stakeholders and advocate for regulatory frameworks that can accelerate industry change and end smoking. Business transformation is a company-specific journey, which sustainability reporting standards and frameworks often fail to adequately capture.

To help illustrate our progress towards achieving our smoke-free purpose, we regularly report our business transformation metrics, a bespoke set of financial and non-financial KPIs. Some of them were already presented by Emmanuel in our financial results. Others you can see here. For example, the growing proportion of commercial and R&D spend on smoke-free products demonstrates the allocation of resources away from our legacy business and towards replacing cigarettes with better alternatives. As another example, increasing the availability and access of adult smokers around the world to smoke-free products are two key pillars of achieving this replacement. As our geographic expansion continues, low and middle income markets now make up 47% of our market presence. These metrics, together with our overall performance for 2023, can be latest integrated report, published last month and available on our website.

It is a comprehensive document covering our most important sustainability topics, starting with our products. The report highlights progress on our continued expansion of smoke-free alternatives across categories and geographies, as well as social and environmental progress, with and in parallel to these products in support of sustainable value creation. This includes responsible marketing and sales practices, youth access, and efforts to reduce post-consumer waste. Further, it highlights our progress on improving the quality of life of people in our supply chain, decarbonizing our operations and value chain, and preserving nature. We're also very pleased with the continued recognition of our sustainability performance and our robust reporting. To highlight just a few from 2023, PMI was included in the Dow Jones Sustainability World Index for the first time, and for the fourth year in the DJSI North America.

In addition, PMI was the only U.S. company to obtain a triple A rating from CDP. More than 20,000 companies worldwide participated in this rating, and only 10 obtained this prestigious recognition. Notably, for investors in parts of Europe, but also in ESG or sustainability-themed funds in the U.S., we are subject to sector exclusion policies because we're a tobacco company. It is clear that excluding companies or sectors from the consideration set does nothing to address the underlying reasons for the exclusion, which in our case, would be the harm linked to combustible tobacco use. Many funds that may be excluding tobacco on ESG considerations will still own stocks in other consumer sectors, despite many of these companies not having comparable harm reduction strategies in place to address the impacts of their products.

As we transform our company away from combustible and work to end smoking at a societal level, we welcome the engagement and challenge of investors to help us accelerate this critical shift. Thank you. I'll now turn it back to Emmanuel.

Emmanuel Babeau (CFO)

Thank you, Jennifer. I will conclude today's presentation with some key messages. Our excellent IQOS and VEEV volume momentum, best-in-class pricing, positive category mix, and stepped-up cost efficiency put us on track for a strong 2024, with accelerated top line growth and margin expansion. Following an exceptional and better than expected start to the year, we have raised our full year currency neutral growth forecast. Critically, we are also focused on delivering performance in dollars. We are taking measures to mitigate currency headwind through pricing, accelerated manufacturing productivity, and judicious resource allocation to prioritize growth investment. Our 2024 outlook places us firmly on track to deliver our 2024-2026 CAGR targets. Beyond 2026, we have further exciting opportunities to grow our smoke-free business as we progress towards our ambition of being substantially smoke-free by 2030.

Finally, and importantly, our strong growth outlook and highly cash generative business underpins our ability to deleverage while maintaining a steadfast commitment to our progressive dividend policy. We look forward to further rewarding our shareholders as our transformation delivers sustainable growth. Thank you, and we are now very happy to answer your questions.

Operator (participant)

As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question comes from Matt Smith with Stifel. Your line's now open.

Matt Smith (Managing Director)

Hi. Thank you, Emmanuel.

Emmanuel Babeau (CFO)

Morning, Matt.

Matt Smith (Managing Director)

If we start the first quarter, it was a strong start to the year. You noted a better revenue and margin performance, supporting your ability to raise the outlook for both organic revenue and constant currency EPS. From a high level, on a constant currency basis, the first quarter EPS was about $0.20 ahead of your 1Q guidance, and you raised the full year outlook somewhat below that. Can you talk about unique benefits in the first quarter that may have changed the timing through the year? Or how are you viewing the rest of the year different now in terms of the fundamental environment or investment level?

Emmanuel Babeau (CFO)

Sure, Matt. No, I'm happy to explain why some of the bits, but only part of it, of course, because we started, as I explained, on my prepared remark, the year in a very strong manner, in an underlying manner. But in addition to the very strong momentum that we are experiencing, indeed, there was around an additional one billion HTU stick because of Red Sea. So that has been a plus in Q1, and we expect that to reverse later in the year for the time being. So that's one element that is important. We may have been helped a bit by some volumes on combustible, but it's probably more marginal and, you know, at the scale of the combustible business, it's probably smaller.

And then the other element, of course, is the SG&A evolution, organically, 1.4% increase only. We want to grow organically revenue faster than SG&A, but of course, we won't have the ten points of difference that we've been experiencing in Q1. So that will also reverse partially in the rest of the year, as we are coming with some phasing on commercial actions and marketing, advertising later in the year and starting in Q2, where we will have more SG&A. So I think that with that, you have the key elements that have been adding to what was, as I said, a very strong momentum anyway in Q1.

Matt Smith (Managing Director)

Thank you, Emmanuel. I'll pass it on.

Emmanuel Babeau (CFO)

Thank you.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from Bonnie Herzog with Goldman Sachs. Your line's now open.

Bonnie Herzog (Managing Director)

All right. Thank you. Good morning.

Emmanuel Babeau (CFO)

Good morning.

Bonnie Herzog (Managing Director)

Emmanuel, I wanted to maybe ask for a little bit of more color on a point you made about, or at the end of your script, regarding currency headwinds and how you're hoping to mitigate these headwinds. You know, you highlighted pricing and productivity savings, et cetera. So, you know, maybe just provide a little bit more color on those, you know, I guess, levers, if you can pull them, and maybe why you're more optimistic going forward, given the never-ending currency headwinds, since it continues to impact your business. I think that would be helpful.

Emmanuel Babeau (CFO)

Sure, Bonnie, happy to to share our view and what we're doing on that one. So we said it at the beginning of the year, and then we're at CAGNY, we want to deliver performance in dollar terms, and therefore that mean that even when we have another significant Forex headwind, and you know, some of that, I mean, we have in Q1, actually 6 cents coming from the Egyptian pound, that won't be there next year. So that's not something that's gonna stay with us. So, it's a kind of one-off negative impact, but we want to deliver robust growth in dollar terms. So, in order to deliver that, we have two big levers, I would say. The one is on price.

To be clear, when we talk about price, it's, of course, in the countries where we can see some devaluation, but not only. It's really across the board, how can we push the boundaries and push, you know, to the maximum of the limit, the price increase? Well, we think that we're doing in a way that is not necessarily taking a big risk on market share, but we are clearly here, and notably on combustible pushing on price increase. So that's something that we can do that is taking into account a certain economic environment. In the current environment, we are doing, you know, what we think is optimized and the best we can.

Of course, if there was some more depreciation, more devaluation, we would reconsider whether more action can be done. And then on productivity and on cost efficiency, that means really accelerating everything we can do on productivity, and we are working across the board. It's of course on procurement, it's on optimizing the manufacturing footprints, it's on logistics, I mean, it's on everything where we can generate extra savings, and you know, playing with this environment of a strong dollar. And then on cost allocation, I mean, of course, we are working permanently as part of our $2 billion savings program on plans to be simpler, to generate efficiency, to work in a more efficient manner. So, we do that, we try to accelerate that.

Here again, we're trying to do things faster. And we are also making sure that when it comes to investment allocation, we really prioritize on what is having the biggest and strongest, and I would say clearest return, which is allowing us to also generate some profitability improvement to partially offset the negative Forex. So that's really everything that all the action that we are doing. We're not saying we can offset any kind, of course, of Forex environment, but I think our Q1 numbers and the outlook for the year is showing that we have some good capacity to mitigate to a very significant extent the Forex impact.

Bonnie Herzog (Managing Director)

Okay, that is helpful. And then I just had a quick question, if I may, on ZYN. We're actually hearing about some out of stocks in the U.S. from some of our industry trade contacts. So, you know, maybe hoping for a little more color on this and, you know, how much it might have impacted volumes in the quarter. Also, you know, curious if these issues are related to maybe specific production issues or, or more related to the strong demand, and ultimately when you expect them to be resolved. Thank you.

Emmanuel Babeau (CFO)

Thank you. Thank you, Bonnie. This is very much the latter. I mean, you can imagine when a business is growing 80%, and we are growing 80%, that is indeed creating some tensions on the supply chain without any doubt. I'm not sure that out of stock is still the proper word, you know, given where we are today. I think that, you know, maybe sometime a reference is not gonna be available. You know, not everything is gonna be, is gonna be, is gonna be fully available in, in the range at a, at a certain point in time. But look at what, you know, the Nielsen are telling us on, on Q1 and our volume.

I mean, we seem to be growing fast and it's difficult to see any kind of impact coming from restriction on availability. As we said, we are working very hard to maximize our capacity in this fast-growing environment for ZYN. We are comfortable, of course, with our capacity to deliver around our 560 million can. That is not the limit that we are putting, of course, in terms of production capacity, but we are in this a phase of adaptation to this strong growth and fast-rising demand. I think so far, maybe with some tension, but with limited impact on volumes.

Bonnie Herzog (Managing Director)

Okay, thank you.

Emmanuel Babeau (CFO)

Thank you.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from Owen Bennett with Jefferies. Your line is now open.

Owen Bennett (SVP of Equity Research)

Morning, Emmanuel, hope all well.

Emmanuel Babeau (CFO)

Hey, Owen.

Owen Bennett (SVP of Equity Research)

Hey. First question on heated, can you maybe talk a bit more about the contribution from newer markets? Is this trending in line with expectations, or do you see potential for upside here? Because some of the trends you called out sound very encouraging. And I'd also love an update on BONDS and the latest with this, if possible. Thank you.

Emmanuel Babeau (CFO)

Yeah, with pleasure, Owen. So, I think we see and you said it, I've been elaborating on the number of markets where we see a very interesting trajectory for, you know, new markets. We've been speaking about Indonesia. We could have been speaking in addition to all the markets I've been covering, I could have been speaking about Mexico, where we have also a nice acceleration, and we are just launching ILUMA now. So the good thing is that we're not relying on one or two names, but we start to have a growing team of new markets where we see clearly IQOS getting traction and increasing its stake.

First, as always, in the big cities, that's where, in many of these countries, we have the biggest potential. But that's, I would say, happening in line with expectation. And as I said, we expect even a further acceleration in the second part of the year. We believe that then, you know, Taiwan will also start, so adding to the flow of this newer market. So it's in line with expectation and clearly coming with a great potential, with IQOS being perceived as you know, in many big cities, rapidly as an aspirational product, which is extremely positive for the future and the brand franchise that we're gonna be able to build there.

Then on top of this, new market, and the IQOS trajectory in this new market, we have indeed BONDS that we plan to develop in the future. We've been making the test, as we explained, in the Philippines and Colombia. We are working on the result. We are making a number of adjustments, and we'll come with a detailed plan, in the coming quarters. We want to make sure that we come with a product that has all the ingredients, all the features to be a great success, and we're working on it.

Owen Bennett (SVP of Equity Research)

Great, thanks.

Emmanuel Babeau (CFO)

So that's gonna be really important in all this market because we know that the affordability here is different. To come with a portfolio that is segmented and where IQOS will have a role to play, but we'll need to also come with the rest of the portfolio BONDS, lil, in order to cover this market.

Owen Bennett (SVP of Equity Research)

Thank you. Very helpful. And I just add one more. I want you to talk a bit more about vape. What sort of volumes do you think you can do here for the year? And if I heard you right, you said you'll be profitable already in H2, which would suggest volumes have been really healthy already. And just any kind of commentary on which markets you're seeing the strongest traction so far?

Emmanuel Babeau (CFO)

Sure. So on the, it of course stays modest, you know, versus IQOS and VEEV in terms of impact at the group level. And we stick to our strategy, which is we don't want to be big in vaping if it's to lose money. We want to be really going with VEEV in market where we are having the right commercial impact, where VEEV can make a difference and in a profitable manner. Indeed, the year started well in terms of volumes. We have this outlook of moving into positive bottom line for VEEV in the second part of the year, which would be very good news. And we are prioritizing markets where we have the critical mass, where the, I would say, the nature of the vaping market is interesting.

We are developing today very nicely, I would say, in markets such as Italy, Czech Republic, France, U.K., developing in Canada. These are markets where we can reach, if you want, the size, the mass, and where we have the impact to make our vaping business successful and profitable.

Owen Bennett (SVP of Equity Research)

Great. Thank you, sir. Very helpful.

Emmanuel Babeau (CFO)

Thank you, Owen.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from Faham Baig with UBS. Your line is open.

Faham Baig (Executive Director of Equity Research)

Morning, Emmanuel. Thank you.

Emmanuel Babeau (CFO)

Hi, Faham.

Faham Baig (Executive Director of Equity Research)

For all the questions. I have a couple as well, both on heated tobacco. Firstly, could I get your view on any implications that you see from the recent EU court ruling on the supplementary excise tax in Germany, to any other of the European countries? And when are you expecting a decision from the finance court in Düsseldorf? And the second question, please, is again on heated tobacco. Clearly pricing has stepped up over the last couple of quarters. How are you thinking about balance between price and volume growth? And could pricing be higher than the original guidance of low single digits?

Emmanuel Babeau (CFO)

Thank you for the question. So first of all, on the German situation, it's a... I mean, yes, they've been asking for the view from the European Court of Justice, but it's a purely German question, whether the way they've been implementing their extra tax was according to EU law or no. So there is no consequences for other countries. It's really a German question due to how they implemented this increase in the tax. So that's what it is. On the final decision, because at the end of the day, that would be the decision from the German court, I have to say, I don't know when we will know more.

I, I guess in the coming months, obviously, but I'm not gonna be able to be more specific, on the timing of the Düsseldorf court to make their decision. There, there are a number of steps to, still need to be taken, before they get there. So that will be for the coming months. I think given where we are today, I'm not able to tell you when they will, make their decision. Regarding your second question on price versus volume. So we said, and I'm gonna stick to that, yeah, we believe that we can increase price, more, you know, low single digits or not at the level of combustible on heat-not-burn. Again, I think we are very clear on the very positive impact coming from the growth in volume, from our heat-not-burn business.

They're coming with a much higher per stick revenue. They're coming now with a higher growth margin rate, even at the level of just the consumable, it's significantly higher than for combustible as an average for the group. So that means that really growing volumes is the name of the game for us. That's where it makes sense. Now, on top of it, I mean, given the very strong franchise of IQOS and the attractiveness of the brand, we are able to increase price without putting in danger the volume. But that's really the way you should be looking at it. For us today, it's very much a play on maximizing the volumes.

Faham Baig (Executive Director of Equity Research)

Thanks, Emmanuel.

Emmanuel Babeau (CFO)

Thank you.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from Gaurav Jain with Barclays. Your line is now open.

Gaurav Jain (Head of EU SMID, EU packaging, Global Tobacco, and Cannabis)

Hi, good morning, Emmanuel.

Emmanuel Babeau (CFO)

Morning, Gaurav.

Gaurav Jain (Head of EU SMID, EU packaging, Global Tobacco, and Cannabis)

Thank you for taking my question. So 2 questions from me. So one is, you know, just conceptually, so, you know, let's take a city like Tokyo, where the heated tobacco category share is now 50%+. So one can argue that by increasing the premium cigarette prices, which haven't increased now in 2 years, you can accelerate the down trade into IQOS. This will accelerate IQOS volume growth, this will also accelerate your dollar EPS growth out of Japan. So why wouldn't you do something like this in cities and countries where heated tobacco and IQOS becomes the dominant form factor?

Emmanuel Babeau (CFO)

Thank you for your question, Gaurav. Look, you know, I'm always very cautious, of course, as you can imagine, on commenting any kind of price strategy, so don't expect me to enter into any kind of detail. But conceptually, it is clear that as we build leadership in the category, as there is a growing addition from the nicotine user to heat-not-burn, there is a capacity for ongoing premiumization and more price increase, without any doubt. But as I said, and as I explained in, you know, with the previous question, we believe that today, still it's very much about maximizing the volumes, and that's what for us is important, of course, coming with great gross profit per stick and great contribution.

So I'm certainly not closing the door to more price in the future, but I think I've been clear on what our priorities are. Having said that, as you know, in Japan, we need to have an agreement from the authority to increase the price. So I think it's something that is also sometimes regulated, so it doesn't mean that we have all the latitude that we would like to enjoy on the topic. So that's.

On the long term, it is clear that today, as – and we've been discussing that already, you have the IQOS consumable that are positioned, you know, even at some discount versus Marlboro, that gives an idea of the kind of increase that we'll be able to reach in the future, probably without too much, I would say, issues over time. Once again, you know, it doesn't happen in one go. But as I explained, for the time being, maximizing volume is the name of the game, and it's coming with, I think, what the Q1 is illustrating in a very bright manner, a very, very powerful mix impact on our financial performance.

Gaurav Jain (Head of EU SMID, EU packaging, Global Tobacco, and Cannabis)

Sure. My second question is on Russia. So, you know, IQOS volumes in Russia grew, which is surprising, given that you do not invest in IQOS there anymore. So how should we. So first of all, can you just remind us the contribution of Russia on your EPS? And how should we think of, think of Russia IQOS shipments for this year?

Emmanuel Babeau (CFO)

Look, on Russia, you have to be a bit cautious on the shipment that you see. And that does not necessarily fully reflect the consumer off-take. You can have some movement from, you know, the surrounding country, so I think we have to be cautious. So Russia is a market that has not been... If I look at the past, I'm not sure that one quarter is enabling us to conclude anything. Since the beginning of the war in Ukraine, Russia has been a market that, you know, has not shown, unfortunately, any kind of meaningful growth. Today, we have no reason to believe that suddenly Russia is going to become a growth market because, you know, nothing has changed fundamentally.

And that's a country that has been impacted, of course, by a currency depreciation that has been impacting the weight in the EPS. So I think that we were referring to 7%-8%. I think we'll have to revise, and I don't have the number top of mind for 2024, you know, on the outlook, but that was the kind. It was around nine, 10, and I think with the currency, it has been losing a bit of weight in the overall performance of the company.

Gaurav Jain (Head of EU SMID, EU packaging, Global Tobacco, and Cannabis)

Sure. Thank you so much, Emmanuel.

Emmanuel Babeau (CFO)

Thank you.

Operator (participant)

Thank you. Our final question comes from Callum Elliott with Barclays. Your line is now open.

Emmanuel Babeau (CFO)

Bernstein, right?

Callum Elliott (Director and Senior Analyst)

Yes, Bernstein. Thanks, Karim. So my question is actually a follow up on Bonnie's question on dollar growth, and look, in 2013, I think your dollar EPS, Emmanuel, was $5.40 per share. So you've compounded dollar EPS growth at about 1.5% over the subsequent 10-11 years. So best in class organic growth and probably worst in class dollar EPS growth over that 10-year period, which is really striking, given that that 10 years captures the whole of the creation of this IQOS business that has been quite remarkable. So my question is, you obviously outlined a number of initiatives in answer to Bonnie's question of how you hope to drive dollar growth. But maybe you could sort of double back on those explanations.

Which of those are actually new, and that haven't been present over that sort of past 10-year period, that could have been helping you over that past 10 years? 'Cause it struck me in those explanations that it sounded like things like pricing, et cetera, those have all been around for the past 10 years, and they haven't helped you offset the FX. And so is there anything you can tell us that's new, that should give investors confidence that if FX headwinds persist, you are able to drive dollar growth for your business?

Emmanuel Babeau (CFO)

Thank you for your question. Well, first of all, I guess you are assuming that the forex headwind will persist in the coming years, which I think nobody can really say, you know? We know that currencies can face cycles, and that it's true that the last 10 years have been about a strengthening of the dollar. We've known other cycles where the dollar was more weakening versus at least, you know, other hard currencies, so nobody knows what's going to happen. I think what we are saying, and thank you for giving me the ability to maybe repeat and clarify, is that we are today in a position to put together very strong growth before forex.

I think you are seeing with the guidance for 2024, that we are obviously coming still with a very dynamic top line, very much accelerating operating income growth. We are targeting a double-digit before currency impact now in 2024. On top of that, we are going to price and in an environment that today we see positive for pricing, certainly with the fact that pricing on combustible is something that we can use now very tactically. We know that CC is not our future, so we can certainly use pricing very tactically in order to boost performance. We also are coming with some price increase at the level of HTU. We have some price increase on ZYN as well. So we have globally a pricing environment that looks attractive to us in the future.

And then when it comes to our cost, it is true that we've been investing a lot in the past years, and we've been reporting on all the action that we were having on investment across the board, you know, in term of innovation, in term of science, in term of R&D, in term of manufacturing. Now is the time where, of course, we are reaching critical mass on smoke-free product. There are a number of things that we are doing that we can do more efficiently, a number of things that we've been learning and that we're going to implement in the continuation of our journey. So all that, we believe, is also giving us some very good ammunition and capacity to generate efficiency at a very high level in the future. So that's all the...

and they are quite important, quite numerous, all the levers that we own to deliver performance in dollar terms in the future.

Callum Elliott (Director and Senior Analyst)

Thanks, Emmanuel, that's helpful. Maybe I can just ask you a follow-up?

Emmanuel Babeau (CFO)

Sure.

Callum Elliott (Director and Senior Analyst)

So we have a number of US consumer staples companies reporting this morning, and many of them face similar FX headwinds, sort of incremental FX headwinds over the past two, three months, as PMI does. It's striking to me that amongst some of those companies, even a commoditized US toilet paper company has done a better job this quarter of offsetting these incremental emerging market FX headwinds with sort of rapidly responding with incremental price increases to offset those headwinds. So I guess my question here is, you know, is there something structural in your business that's making it less agile in responding to these changes in FX, relative to some of your other consumer staples peers outside of the tobacco space?

Emmanuel Babeau (CFO)

Well, can I answer you that your question is highly speculative, because you asked me to compare with other businesses that are obviously very different in, I guess, the way they invest their outlook, what they have to do. We are building here a business that has a tremendous growth potential, so we're not going to, of course, limit all the initiative, all the investment that we must do in order to keep growing the business and extract the full potential that we have with our smoke-free portfolio. Maybe that's a different versus the, you know, paper business you were mentioning. I frankly have no clue, because I don't know what you are referring to and their specific situation. But I think it's difficult to probably compare businesses that are facing different potential, different trajectories.

That would be my answer.

Callum Elliott (Director and Senior Analyst)

Okay. Thank you.

Emmanuel Babeau (CFO)

Thank you.

Operator (participant)

Thank you. This concludes the question and answer session. I'd now like to turn it back to management for closing remarks.

James Bushnell (VP of Investor Relations)

Thank you for joining us. That concludes our call today. If you have any follow-up questions, please contact the investor relations team. Thank you again, and have a nice day.

Emmanuel Babeau (CFO)

Bye-bye. Speak to you soon.

Operator (participant)

This concludes today's conference call. Thank you for participating, you may now disconnect.