菲利普莫里斯國際 (PM) 2019 Q1 法說會逐字稿

Good day, and welcome to the Philip Morris International First Quarter 2019 Earnings Conference Call.

Today's call is scheduled to last about 1 hour, including remarks by Philip Morris International management and the question-and-answer session.

(Operator Instructions)

I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications.

Please go ahead, sir.

Welcome, and thank you for joining us.

Earlier today, we issued a press release containing detailed information on our 2019 first quarter results.

You may access the release on www.pmi.com or the PMI Investor Relations app.

A glossary of terms, including the definition for reduced-risk products, or RRPs, as well as adjustments, other calculations and reconciliations to the most directly comparable U.S. GAAP measures are at the end of today's webcast slides, which are posted on our website.

Unless otherwise stated, all references to IQOS are to our IQOS heat-not-burn products.

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.

It's now my pleasure to introduce Martin King, our Chief Financial Officer.

Martin?

Thank you, Nick, and welcome, ladies and gentlemen.

We're off to a promising start in 2019, reflecting positive momentum for our combustible tobacco and smoke-free product portfolios, strong currency-neutral adjusted financial results and the important milestone of reaching over 10 million IQOS users globally.

As we announced in our press release this morning, we are revising our 2019 reported diluted earnings per share guidance at prevailing exchange rates to be at least $4.87.

The $0.03 revision compared to our prior guidance on March 22 of at least $4.90 is due to 2 specific factors: first, a $0.02 increase in the estimated net impact of the deconsolidation of our Canadian subsidiary, Rothmans, Benson & Hedges Inc., RBH, representing a total charge of approximately $0.12 per share based on final quarter-end figures; and second, asset impairment and exit cost of approximately $0.01 per share related to a plant closure in Pakistan as part of our global manufacturing footprint optimization.

Our guidance continues to include an unfavorable currency impact at prevailing exchange rates of approximately $0.14 per share with essentially the entire amount or $0.13 coming in the first half of the year.

After excluding the $0.22 per share of reporting adjustments outlined on this slide, our forecast represents a projected currency-neutral increase of at least 8% versus our pro forma adjusted diluted earnings per share of $4.84 in 2018.

For the year, we continue to anticipate a total industry volume decline for cigarettes and heated tobacco units of approximately 2.5% to 3%.

Furthermore, on a like-for-like basis, adjusting for the deconsolidation of RBH, we maintain the following full year assumptions: a total PMI shipment volume decline of 1.5% to 2%; currency-neutral net revenue growth of at least 5%; currency-neutral adjusted operating income margin expansion of at least 100 basis points; operating cash flow of approximately $9.5 billion, subject to year-end working capital requirements; and capital expenditures of approximately $1.1 billion.

Turning now to the first quarter.

We recorded a total shipment volume increase of 1.1% driven by the strong growth of heated tobacco units, notably in the EU Region and Russia.

Our cigarette shipment volume was stable, supported by growth for each -- from each of our top 5 international cigarette brands.

Excluding the net unfavorable impact of estimated distributor inventory movements, our total in-market sales volume grew by 1.7% with heated tobacco units up by nearly 35%.

Importantly, our HTU in-market sales volume increased by 10.6% sequentially versus the fourth quarter, reaching nearly 13 billion units.

Net revenues increased by 3.2%, excluding currency, driven by higher HTU shipment volume and favorable pricing from our combustible tobacco portfolio.

Our currency-neutral net revenue growth came despite 2 challenging comparisons versus the first quarter of 2018.

The first relates to sizable IQOS device shipments in Japan last year following the lifting of device sales restrictions.

This is evidenced by the contribution of devices to our total RRP net revenues of approximately 22% in the first quarter of 2019 compared to approximately 35% in the same period last year.

The second relates to the shift to highly inflationary accounting in Argentina effective July 1, 2018, with the U.S. dollar now serving as the functional currency for our subsidiaries in Argentina and the impact of the peso devaluation now included in our currency-neutral results.

Combined, these 2 items represented an estimated drag of approximately 3.4 percentage points on our currency-neutral net revenue growth rate.

Absent which, our growth would have been approximately 6.6%, consistent with our full year assumption of at least 5%.

Our combustible pricing variance in the quarter was nearly 4% and was adversely impacted by a partial excise tax absorption in Turkey and the aforementioned accounting shift in Argentina.

The underlying fundamentals supporting our strong historic pricing remain intact, notably the broadly rational excise tax environment globally and our leading cigarette brand portfolio.

We have recently increased our cigarette prices in markets such as France, Germany, Italy, Mexico and Turkey, which should further contribute to a positive pricing variance over the balance of the year.

For the full year, we anticipate a combustible pricing variance above 5%.

On a currency-neutral basis, adjusted operating income increased by 9.1% and adjusted operating income margin increased by 200 basis points.

Compared to the first quarter of last year, these metrics benefited from the lower device shipments noted earlier in my remarks given their dilutive unit margins.

Adjusted diluted EPS increased by 15%, excluding currency, driven by our strong business performance, coupled with the favorable impact of a lower effective tax rate and lower interest expense.

Our total international market share, excluding China and the U.S., increased by 1 percentage point in the first quarter to reach 28.4%.

Half of this growth was driven by heated tobacco units, reflecting broad-based share gains across markets where IQOS has been commercialized.

Our cigarette portfolio contributed the balance of the growth despite the impact of out-switching to heated tobacco products with higher share in markets such as Egypt, Germany, Thailand and Turkey.

Importantly, our share of the cigarette category alone increased by 0.7 percentage points to 27.1%.

Our total international share growth was driven by higher share in 5 of our 6 regions.

The decline in the East Asian Australia region mainly reflected the impact of lower cigarette share in Japan and Korea.

Moving now to RRPs.

We reached a key milestone in the quarter, surpassing 10 million IQOS users.

Importantly, approximately 70% of the total have stopped smoking and switched to IQOS, with the balance in various stages of conversion.

In Japan, we're seeing encouraging trends in IQOS device ownership, IQOS past 7-day use, heated tobacco category share and our HTU offtake share as evidenced by the 3-month moving average figures presented on this slide.

These trends suggest that the range of initiatives for restoring share growth that we initially outlined last May and introduced during the second half of the year are, indeed, starting to pay off.

And while we anticipate increased competitive activity in the category over the course of this year, this could actually serve to accelerate category growth.

Our share for HeatSticks and HEETS in Japan reached 16.9% in the first quarter or 16.6% after adjusting for estimated trade inventory movements.

This marked our first sequential share growth since the first quarter of 2018 and is the highest quarterly share that we have achieved in the market.

Importantly, as shown on this slide, the sequential growth of the heated tobacco category in Japan in the first quarter was driven primarily by our HTU brands.

In Korea where the heated tobacco category continues to be highly competitive, our market share over the recent quarters has been distorted by the impact of inventory movements, which we initially noted during the full year earnings call in February.

On an adjusted basis, the share of HEETS remains stable sequentially at an estimated 7.8%.

In the EU Region, HEETS continued its sequential share growth, increasing by 0.4 percentage points to reach 2.1%.

The growth was driven by essentially all IQOS markets and reflects success across a broad range of countries with varying regulatory frameworks and adult smoker preferences.

It is worth noting that the government in Italy recently lowered the excise tax for innovative smoke-free products such as heated tobacco and e-cigarettes.

As a result, effective April 5, we adjusted the retail price of HEETS to EUR 4.50, in line with the lowest price point for cigarettes.

We believe that this is an important step to help accelerate the transition to a smoke-free future.

HEETS also continued its strong performance in Russia with national share up by 1.3 percentage points sequentially to reach 3.1%.

The increase was flattered by the impact on the total market of seasonally lower cigarette industry volume.

Given this effect, we believe that the in-market sales volume progression with sequential growth of over 30% in the first quarter provides a more realistic indicator of the brand's trajectory.

Our in-market sales growth mainly reflects the progress of our local organization in existing IQOS-focused geographies, the impact of positive word-of-mouth from the growing number of IQOS users, our omnichannel strategy and further geographic expansion.

We are now commercializing IQOS in 35 cities, representing an estimated 32% of the market by total industry volume.

As noted during our earnings call in February, our HEETS shipment exceeded their in-market sales in the fourth quarter of last year driven by our planned geographic expansion.

While this contributed to an unfavorable impact on our HTU shipments of approximately 600 million units in the first quarter, it had no material impact on our in-market sales volume or market share.

In conclusion, we're off to a promising start to the year.

The fundamentals supporting our strong combustible tobacco portfolio remain intact.

Favorable momentum for IQOS across geographies, including Japan, is driving HTU share gains and further supports our confidence in our HTU shipment volume target of 90 billion to 100 billion units by 2021.

Finally, on a like-for-like basis, we're on track to deliver against our full year currency-neutral net revenue growth assumptions of at least 5% and adjusted diluted earnings per share growth forecast of at least 8%.

Thank you.

I'm now happy to take your questions.

(Operator Instructions) Our first question comes from the line of Judy Hong of Goldman Sachs.

So I guess, it's nice to see Japan getting back on the growth track for IQOS.

If you can share your observation about IQOS 3 and MULTI performing in that country.

And then maybe in contrast that with Korea perhaps where it seems like share trends have been kind of flattish.

So why is Japan doing better versus Korea is my first question.

Okay.

Yes, we're very gratified by the performance in Japan.

I think IQOS 3 MULTI is playing a role in that.

The devices have been very well received by consumers.

It helped us turn the page in Japan on the reliability issue we had with the previous early versions of 2.4 Plus.

Even though 2.4 Plus is now fixed from a reliability point of view, in consumers' minds in Japan, this was part of what they were looking for was to get past that.

And it's definitely helping us with perceptions in the marketplace.

Our new registrations in Japan have increased substantially, and it's in part due to the 3 and MULTI that's there.

HEETS is playing a role as well, and the rollout during the quarter was successful.

It's adding to our share and adding to profitability in the market as it brings in the price-sensitive consumers from cigarettes.

So the plan in Japan is as we had hoped, and it's right on track and doing very well.

In Korea, the issue is very intense competition in the heat-not-burn category.

We're holding our own, but we're seeing some new offerings from competition.

And there is some churn going on there, not unlike happened in the earlier days also in Japan.

And we're working very hard.

The 3 and MULTI are well received in the country, but we're still working through, I think, some of the competitive activity that's going on in that marketplace.

Okay.

That's helpful.

And then sort of your decision to take pricing down for HEETS in EU, just elaborate on kind of what drove that decision.

And then if you can speak to then sort of how does that impact the profitability outlook for IQOS HEETS.

Are there other kind of offsets that you're looking to drive some of the pricing changes?

And why just Europe and not other markets around the world?

Well, actually, it was even more specific than Europe.

It was in Italy only, and it was because the government reduced the tax.

And so we're passing on that benefit to consumers, and we believe that that's the right thing to do.

The profitability remains intact, and it's something that, as we get better tax differentials in various countries, we think it's important when we get a lower tax to reflect that sometimes in the price, so that consumers benefit.

Otherwise, governments are less likely to retain those gaps.

Okay.

Got it.

And then just my last question.

So the first quarter earnings actually came in better than your expectation that you talked about during fourth quarter earnings.

So was there any timing factors?

Or has the underlying business actually done better than you expected in the first quarter?

Yes.

Well, it's both.

There is better underlying business, particularly in the area of EU.

And the volume on conventional cigarettes came a bit stronger than we anticipated.

As far as HTUs, we're right on plan.

But about -- if you take the beat being about $0.09, $0.03 is the currency coming better, which is transactional currency.

Then there's about $0.06 that's more in the business.

And half of that is better underlying performance, and the other half is more spending timing that I think will flesh out in the coming quarters.

So we're on a good start for the year, but it's early days.

And we'll see how the rest of the year unfolds.

Our next question comes from the line of Adam Spielman of Citi.

So I guess, I'd like to ask the same question again from Judy.

Can you explain just a little bit because this is a -- I think in the last 6 quarters, you've given guidance for quarterly EPS 4 times.

And [on each presentation], there'd be some -- by large amounts.

And I'm just wondering how you -- we should interpret that.

Is it because fundamentally, the business is not hugely unpredictable and we just had 4 lucky results in a row?

Or is it -- or is there some other explanation?

And I suppose given that, how conservative are you being for the full year?

Well, I mean, we are off to a strong start for the year, and it's reflected, as I said, in the business results that you see.

We have good margins.

We have good volume.

But it's early days, and we're here in the first quarter only.

For the heated tobacco space, we're right on plan in Japan.

This is very nice share growth, but it's what we planned.

And in EU, it's turning out really nicely.

Everything is developing well.

We're getting the benefit from the investments that we made last year, but it's exactly what we had anticipated and put in the plan.

The part that's a bit further ahead of where we anticipated is the conventional cigarette volume, which is coming both from the total market, which, on adjusted basis, total market worldwide was down 2.3.

So it's very much to the low end of the range we expected.

And our own share is coming quite strong as well on conventional cigarettes to be up in share despite the impacts of cannibalization from HTUs is a welcome development.

Now we'll have to see if these trends hold, and it's really the beginning of the year.

We give the best estimates we can, and I think it's a positive that we're seeing the business performing a bit better.

Anyways, it's fair enough and perhaps it's an unfair question.

But can I ask a few questions that perhaps you can answer specific?

First of all, I was very surprised to see, I think, 31% organic adjusted operating income growth in the EU.

As I read the press release, that was mainly driven by pricing in Germany, Italy and Poland.

But is there any other sort of factors that you can point to?

Because that's a huge increase, 31%, on what should be quite a stable market.

Well, there are 2 other factors.

One is the total market in EU.

It came better than it has for a while.

That's pretty good for EU to be only down slightly.

And our share is doing very well for both cigarettes and heated tobacco units.

And then you get the factor that our volume, our shipments in EU for heated tobacco units are starting to get quite significant.

And you have to remember that our margins on those shipments are considerably better than cigarettes.

So you get both the weighting of HTUs at a higher margin, and you get better trends on the volume for both cigarettes and heated tobacco units.

We're also getting more efficient on our spending.

We made significant investments in infrastructure, and we've learned how to better convert smokers to the heated tobacco to IQOS and do it more efficiently and effectively.

So if you look at our costs, the step-up across all the regions actually, but in EU, it was much smaller this year than it was last year.

And we're benefiting from the investments we made before.

We're also scrubbing our costs on the other existing areas in the company as we committed to doing, and we're doing a better job controlling the costs.

So all of those coming together to give some good -- pretty good results.

And I take it from your comments that there has been no impact that you can see from JUUL.

And I guess, the question behind the question is back in, I guess, November, December when we discovered they were going to go international, we thought there was a risk that JUUL would hit volumes perhaps in the U.K., perhaps in Canada, which I suppose we no longer talk about, perhaps in Germany.

But I get the impression it had no impact that you can see.

Yes, that's correct.

We haven't seen any impact from JUUL in any countries on our volumes...

And the final question -- yes, and the final question from me is you've highlighted, as I said, particularly the EU, very good operational income growth.

Is there any factors you'd highlight in the rest of the year that maybe sort of caused it to fall in perhaps a way that's not obvious to the informed onlooker?

Or should we just sort of extrapolate this very good performance in Europe going forward?

Well, I can't think of any event to call out that would cause our performance to falter in any way.

I'm -- I don't know that you'll see the same percentage increase each quarter going forward because there are other factors involved.

But the trajectory and the trends, I think, are good.

And yes, I believe EU will have a good year this year.

Our next question comes from the line of Michael Lavery of Piper Jaffray.

Well, you touched on the advantages that the heated tobacco units have in Europe compared to cigarettes.

Can you give a sense -- we have a little bit of color on a couple markets like Italy and Germany.

I guess 2 questions.

One, are they somewhat representative of the EU broadly?

And then second, in Italy, with the lower taxes and also the lower price, does your economic advantage increase at all with that lower price?

Or is it constant?

How does your price adjustment and with the tax adjustment compare to where you would have been prior to that?

Well, Italy and Germany, probably overall, have slightly higher margins for heated tobacco units than most of the other countries.

They both have a pretty good advantage from a tax perspective, Germany particularly so.

As far as the price increase, I mean, we've passed the tax advantages on to the consumer.

Our profitability is at least as good as it was before.

Okay.

That's helpful.

And just looking at the pricing variances that you've cited, first, am I right, just that, that is pricing and it doesn't reflect mix, for example, a revenue mix lift from heated tobacco units?

And if that's correct, do you have a sense of how much mix benefit you get from the growth of the HeatSticks as part of the bigger part of the portfolio?

Yes.

The pricing that was mentioned in the script was reflective of conventional cigarettes pricing over conventional cigarettes revenue.

We do, of course, get a mix benefit as we grow heated tobacco units.

If you look at mix company-wide, it's a little more complicated because we also have the effective geographic volume differences at higher or lower margins.

So for example, if Turkey grows volume as what happens in the first quarter this year, that tends to be at a lower margin than the volume in, say, EU that we mentioned before.

So that factor comes into the mix as well.

So the company-wide mix is not so clear.

But overall, there's a mix benefit, absolutely, as we grow heated tobacco unit volumes around the world because everywhere that we commercialize, we have higher margins on heated tobacco units than the cigarettes in that same given market.

Great.

That's helpful.

And that's again just over and above the pricing that you called out, correct?

Well, the pricing for the year, it's going to vary.

Overall, the main takeaway is that the pricing conditions are intact.

The pricing power is still there.

The brands are strong.

You see that in the share gains.

So we are very encouraged by the pricing environment.

It does vary.

You have a number of factors going on in this quarter.

For instance, Argentina being out of the pricing variance.

That reduces it significantly.

In the second half of the year, the comparison will be better.

In Turkey, we absorbed tax in the first quarter.

We've now taken pricing in Turkey recently.

Russia, there's a tax timing difference.

The tax increase was in January this year, whereas last year, it was in July.

So the comparison for the first half of the year is more difficult.

And then there are some countries like Philippines, for example, where we had very, very nice pricing last year.

But it was more an issue of closing the gap from the JTI acquiring the Mighty brands and the true tax, excise tax being fully reflected in the price.

So that closed price gaps in the market last year and even starting in the year before.

And so we had very nice pricing as that catch-up occurred, returning more to the price that should be in the market.

And so the comparison against this year, while we continue to have good pricing variance and we anticipate still to have a good pricing variance in the Philippines, it's not nearly as big as it was last year.

So all these factors come into play.

On top of that, we just took the pricing in France, Germany, Italy, Mexico, Turkey.

And we're going to keep looking for pricing opportunities as we go forward.

So we're confident we'll be over the 5% for the year.

And it's a pretty good pricing environment overall.

And then, can you just touch on the competitive environment for heated tobacco in Japan?

There's been some new product launches.

Obviously, you're still growing there or even picking up versus where you were last year.

What have you seen from any of the competitive initiatives?

Is it too early to really have a read?

Or what's the right way to characterize the competitive dynamics there now?

Well, right now, we're the ones growing.

As we showed you on the chart, we're driving the category growth and taking pretty much almost all of that growth into IQOS-related consumables.

Now there are some new products that have been launched but very limited amounts, so it's hard to see how they're going to do.

And then later in the year, probably in the October time period or so is what we understand from competitors that they're trying to launch some additional products, which has a combined effect.

One positive from it is it could very well help accelerate the category growth.

One of the problems we've called out in the past in Japan is as consumers try other products in the heat-not-burn space, in many cases, they have been disappointed and dropped out of the category as opposed to being satisfied by the products and staying with it.

So IQOS still has, by far and away, the best conversion rates, of anything, out there.

We'll see if these additional launches are products which people can convert to more readily.

But I think we're still confident that we'll have the best product in the marketplace based on everything we know today.

Our next question comes from the line of Vivien Azer of Cowen.

So sticking with the theme of competition in Asia, can you just elaborate a little bit on the competitive activity that you cited in South Korea?

Any color around relative price points or promotional activity would be helpful.

Well, the price points on the consumables is pretty much clustered around the KRW 4,500 per pack.

I think there's maybe 1 competitor has slightly lower price.

The differences on the devices, though, is larger.

IQOS 3 and MULTI are priced at a premium versus most of the other devices.

And -- but the bigger driver, I think, is on the consumables side.

And in Korea, there is very little price tiering.

It's all -- the whole market's mostly clustered around that same -- including cigarettes, by the way, clustered around that same KRW 4,500 per pack price.

So given the limited price variance on the consumables, is it your understanding or your belief that it's the larger variance on the hardware that's driving the heightened competitive activity and your sequential share loss?

Is it differences in flavor variance?

Well, first of all, our share is stable.

I mean you're getting some distortions in the reported number from the effects of the graphical health warning volume that was shipped in the fourth quarter last year that we had called out.

And you're paying it back in the first quarter.

Our in-market sales share adjusted for those effects is stable at 7.8%.

So we're holding our own.

That's the good news.

We do recognize that we need to continue to broaden our availability of different SKUs in South Korea.

There's a very big role for different flavors.

And you see that on the cigarette side, but you also see it on the heated tobacco unit side.

And we do have a number of different flavors in our SKU lineup, but we continue to look at opportunities to broaden that lineup.

And we'll work to be competitive across that space as well.

Okay.

That's helpful.

And just a second question on IQOS in the U.S. We've heard from the FDA that there will be some kind of resolution on your application by the end of the year.

Can you just remind us when was your last engagement with the agency, what was kind of the nature of the discussion, any specific topics that were raised?

Yes.

Well, we are -- we continue to expect an answer, a decision anytime.

In the past, we have gotten various questions on the application.

We've always answered them right away, and we're continuing to expect to hear from them.

And hopefully, we'll be able to get off and running with IQOS in the U.S. sometime this year.

But I don't have any real update on the timing or any further insight other than the same comments that you probably read at the -- from the TMA that were on the news.

Our next question comes from the line of Bonnie Herzog of Wells Fargo.

I wanted to circle back to Japan and IQOS.

A lot of discussion this morning, and your in-market sales increased nicely.

But your shipment volume was down year-over-year and sequentially.

And I know this was due to distributor inventory movements.

But I guess, I was hoping you could drill down just a little further on this and maybe walk through some of the key dynamics for us of what's going on there and then really how we should think about shipments versus inventory builds for the remainder of the year in that important market.

Okay.

Yes, you're right.

It was impacted by the inventory change, which is about 0.7 billion sticks.

So if you look at in-market sales, it was about $6.4 billion.

Now remember, we've had a price increase in Japan, and the market is impacted by that.

So you have about a 4.5% to 5% market decline coming from the usual market decline, plus the impact of the pricing that occurred in October.

So you have to keep that in mind when you're comparing pure volume going back.

So despite the very nice share gain that we're experiencing now, the actual in-market sales volume is not as up as much as you might expect because the total market is declining as, of course, it is across all the categories and all the different brands.

So I don't know if that answered your question, Bonnie.

No, no.

Yes.

No, that helps.

I appreciate that.

And then I -- my next question I had was on your planned lowering incremental spend behind IQOS this year.

Maybe help us understand how some of the things that you're doing to invest behind this business have changed or maybe will change versus what you've needed to focus on in the past.

I guess I'm trying to understand where you're at in the cycle in terms of building the business.

And are you -- as you're lowering the spend levels, again, how are these initiatives changing?

And then a second part to that question is margins.

On your outlook for margins in '19 or this full year, you mentioned you expect your margins to expand 100 bps.

But hoping you could highlight maybe some of the key puts and takes for us.

Okay.

Yes.

First of all, just to be clear on the spend, what I think you're zeroing in on is our step-up in net incremental spending, whereas last year, we were about $600 million incremental behind RRP, meaning RRP spend offset by reductions in other areas and shifts, for example, from a CT side and overall cut versus this year, the increment was -- we said it to be about half of that, $300 million.

That doesn't mean we're not spending behind IQOS and commercial launches, everything else.

In fact, our spending really hasn't slowed down.

What we're doing is better covering the step-up from within our existing cost base.

And of course, there's also the factor of some of the things we were spending money on last year were for infrastructure that once you have it in place, like a digital organization, et cetera, can scale to much more volume without adding to it.

So there's 2 factors there.

One is some of the big building blocks being in place and not needing to be increased in line with volume.

And the other one is a more focused effort to wring cost out of everywhere we can throughout the business in order to be able to maintain a very steady and significant level of investment [we timed] the transformation and reduced-risk products but without adding so much incrementally.

And that helps us with our financial objectives, of course.

We've called out at Investor Day this initiative to find over $1.1 billion of cost efficiencies across the whole business.

That includes operations, manufacturing, a number of initiatives we've put in place, zero-based budgeting approach, which is up and running.

We've identified a number of initiatives.

We're starting to apply them.

So you're seeing those benefits coming through in a lower step-up in costs.

But it doesn't mean we've slowed our investments behind transformation RRP.

It's a very deliberate strategy to be able to invest heavily but without having it affect our margins, yes, and other aspects of the business.

And that's what you're seeing.

Did that cover that piece of your question on margins?

Yes.

Okay.

So margins, the 100 basis points improvement is -- part of it is exactly the same discussion.

It's slowing the incremental total costs that we're adding while still benefiting from the increased margin coming from higher volumes of heated tobacco units, especially in the EU where the margins are very attractive.

So it's a variety of different pieces there that help us achieve the 100 basis point at least.

And you see it even in this quarter, we were even above that because of the other factors, the cost in the devices, et cetera, being lower.

So this is a multiyear-focused effort to improve our margins at the same time we invest significantly.

That was really helpful.

And I mean, are there any key headwinds we should think about that will put pressure on your margins as you talk about all the sort of the positives?

I just want to make sure I think through any kind of headwinds that you foresee for the rest of the year.

I don't see anything right now that would prevent us from achieving this 100 basis point, at least, objective.

You could always think of some wild thing that would come from left field, but I can't think of anything that's likely to happen that would keep us from making that objective.

Our next question comes from the line of Pamela Kaufman of Morgan Stanley.

I wanted to better understand IQOS' distribution reach within Europe versus its market share trend.

So thinking about individual countries in Europe, I guess, what percent of relevant distribution outlets is IQOS in?

And how much more opportunity is there for IQOS to expand its distribution reach?

I believe we are around 50% in Europe, maybe a little higher now because that's probably a little bit of an older number.

But the point is we still, within Europe and most of the countries in Europe, are not truly, truly fully national.

And even if the product is available in some places nationally, the initiatives behind converting smokers and the real consumer journey activities, if you will, are more focused still towards the bigger population areas for efficiency reasons and other.

So there is room to grow in EU strictly simply from geographic expansion.

And it's a substantial amount of space still available for us to do that.

And of course, that's true elsewhere as well.

Russia, we called out that just now, with this last expansion that occurred, we're in about 1/3 of the country by volume.

Japan and Korea, we're fully national.

So those 2, there's probably not much room you're going to get from purely geographic expansion.

But in just about every other country that we've launched in, we still have geographic expansion opportunities within the country.

And of course, we can still -- over next few years, we'll continue to add countries as it makes sense.

So there's plenty of room to grow with this product.

Okay.

And then just on Japan, so there is discussion of a potential delay in the consumption tax increase in October.

How would that influence your thinking around pricing?

And would it preclude you from being able to raise prices in the market if the tax increase doesn't go through?

Well, Pamela, I really can't talk about future pricing.

For sure, in general, when there is pricing in most countries, and in Japan, in particular, it's usually easier to do when there's some sort of an event, either a tax increase or VAT increase.

It's not impossible to increase prices absent those, and we have done it.

We did it on Marlboro a couple years ago.

Mevius did it independently the year before that.

So it's not impossible to have pricing in Japan absent tax and VAT.

But obviously, the event creates the opportunity to be able to do it.

Okay.

And just the last question on your expectations for upcoming regulatory development.

Are there other countries where you expect to see changes to favorable tax treatment for heated tobacco?

And just an update on plain packaging.

Any anticipated impact from the implementation of plain packaging in the Middle East in the coming months?

Yes.

I don't know of any particular situation to call out of expected rollbacks in tax with regard to novel tobacco products.

But I mean, we make the case with various governments all the time that the ideal way to think about taxes on tobacco products is kind of along the risk continuum.

And if you have cigarettes that are, say, 100% of tax, then you have products that have far lower levels of toxicity and measurable scientifically substantiated benefits that are much, much, much lower, then that should be reflected in the tax.

So we do make that case.

And we have had case situations in other countries where the tax actually improved or the gap improved between cigarettes and heated tobacco unit.

There are a couple of cases actually in the EU.

But I don't -- I can't really call out any going forward, but we'll continue to make the case along those lines.

As far as plain packaging, we have a lot of experience now with plain packaging in a number of different countries.

And so far, it really hasn't had any significant impact on volume, share or any of the other key metrics.

So we're not worried about the implementation of the plain packaging.

I mean, obviously, it's important for us to be able to keep branding and keep the premiumness of our products and so forth.

So we don't think that plain packaging is the way to go.

But if they're going to implement it on cigarettes, then it's not the end of the world.

We haven't seen any big impacts from it.

Our next question comes from the line of Pieter Vorster of Crédit Suisse.

Pieter Vorster from Crédit Suisse.

Just a quick housekeeping question.

Last year in Q1, you made your $80 million annual contribution to the Foundation for a Smoke-Free World in Q1.

Is the timing the same this year, i.e., did you make it this quarter?

Or should we look for it in a different quarter this year?

Yes.

It was the same timing, and we have made that contribution.

And it's the same as it was last year with the size and the timing.

Our next question comes from the line of Radhika Swaminathan of Flowering Tree.

I just wanted to get some of your comments on the Philippines market on the brands.

I mean I see some qualitative comments on up-trading.

So how is that kind of panning out?

Yes.

I mean the Philippines, our share is stable, right?

We're flat share, but we're growing significantly with our Marlboro share versus Fortune.

So we've traded up from mid-price or even low-price brands also from Mighty, Marlboros and so forth, up in the Marlboro as those price gaps close.

So Marlboro is up almost 6 share points in share from the same period last year.

And it's at almost 39% share of the market now, whereas Fortune has dropped by not quite the same amount but about 5 share points, which is part -- is just a function of the gaps -- the price gaps closing between the different brands.

So Philippines, while our share in volume, if you -- our volume was up in the quarter, but it's more of a trade-loading timing so forth.

It's really down slightly overall in the market, and the share is also more or less flat.

But the profitability improves as you trade up from a midprice or low price into the premium.

So Philippines is pretty good story still.

And our last question comes from the line of Michael Lavery of Piper Jaffray.

I just had one other quick question on Platform 2. Could you give us any update on the status there?

It's pretty much the same as we've communicated before, Michael.

We did the test market in the Dominican Republic.

We've learned quite a bit on the consumer side.

The product is actually well received.

It's a product we think will be very successful in the long haul, but we're working on improving the reliability of the product to making sure that, that charcoal heat source is well secured and won't give us any problems in a broad-scale launch.

I mean when you launch in a very big country, you can be shipping billions and billions of units.

So even a very, very small rate of dropping off of the heated tip would be of concern.

So we want to make sure it is absolutely bulletproof and tested and able to stand up in high-humidity environments, for example.

And also, with the new way of attaching the tip and making sure it's right, we need to scale up the manufacturing for it.

And that's taking us a little bit of time.

So we still have a great deal of confidence in this product, and we believe it will play a role.

It would be very nice to have it in a number of markets for more conservative smokers because the ritual is more similar.

And we'll get it out there as soon as we can.

Do you have a sense of what the timing is for when you could commercialize that more broadly?

I really don't have an update right now.

We'll give it to you when we can.

And thank you.

That was our final question.

I'd like to turn the floor back over to management for any additional or closing remarks.

Yes.

I just want to summarize a couple of the key points, I think, going forward.

We're very pleased with the start to the year.

We've got very good momentum.

The combustible tobacco portfolio, the volumes are very good.

I think this is the best volume performance we've had in a very long time.

The share is very strong.

The pricing remains intact, and it's doing well.

So we're very pleased with the base of the business that is the engine that can feed our growth as we move towards smoke-free products.

At the same time, the IQOS is doing extremely well across geography.

We have Japan growing share nicely and on a very good trajectory.

We're able to grow across pretty much every different type of country and geography and consumer preference, regulatory scheme.

And we're seeing really pretty impressive growth in places like Russia and EU.

We're on track to deliver our long-term targets of 90 billion to 100 billion units.

And we're also pleased with the financial results and being able to expand margin and have a good cost approach where we're investing what we need to invest and continuing to feed the growth with substantial investments but at the same time, scrubbing our costs and being very cost-conscious throughout the business to be able to fund that without as much incremental spending.

And we're very pleased to be able to deliver these results, and we'll see as the year unfolds.

And we continue to have good momentum.

We're off to a good start.

So I think that's the main points to take away.

Thank you very much.

Thank you very much.

That concludes the call for today.

If you have any follow-up questions, please contact the IR team.

Thank you again, and have a great day.

Thank you, ladies and gentlemen.

That does conclude today's call.

You may now disconnect, and have a wonderful day.