菲利普莫里斯國際 (PM) 2023 Q1 法說會逐字稿

Good day, and welcome to the Philip Morris International First Quarter 2023 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) Media representatives on the call will also be invited to ask questions at the conclusion of the questions from the investment community.

I will now turn the call over to Mr. James Bushnell, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2023 first quarter results. You may access the release on 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 U.S. GAAP measures for non-GAAP financial measures cited in this presentation and additional net revenue data are available in the exhibit to the Form 8-K published this morning and on our Investor Relations website.

Growth rates presented on an organic basis reflect currency-neutral adjusted results, excluding acquisitions and disposals. As such, figures and comparisons presented on an organic basis exclude Swedish Match up until November 11, 2023. 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 is now my pleasure to introduce Emmanuel Babeau, Chief Financial Officer. Over to you, Emmanuel.

Thank you, James, and welcome, everyone. I am pleased to report that Q1 performance exceeded our expectations with strong underlying momentum from IQOS, ZYN and our combustible business. As mentioned at our full year earnings in February, we expected this quarter to be the weakest of the year due to a confluence of transitory factors impacting our top and bottom line.

In this context, our business delivered robust results, and we look forward with confidence to the remainder of the year. Smoke-free net revenues made up almost 35% of total PMI, despite the impact of adverse timing factors on HTU shipments with an increasing number of markets crossing the 50% threshold. IQOS continued to deliver strong share and user growth across its geographies, both with the blade version and ILUMA.

We have launched ILUMA as excellent traction with both existing IQOS user and legal age smoker is boosting growth, demonstrating the dynamism and importance of our ongoing innovation. ILUMA's progress is especially notable in the first launch market of Japan, where share growth has accelerated in recent quarters. In combustibles, accelerated pricing across a range of markets helped to deliver robust organic net revenue growth. Swedish Match delivered impressive results, with a standout performance from ZYN's plus 47% U.S. shipment's volume growth compared to the first quarter of 2022.

Following an encouraging start to the year, we are well set up to deliver strong performance in 2023, including excellent top and bottom line growth for the remainder of the year. Turning to the headline numbers. Our Q1 organic net revenues saw a robust growth of plus 3.2% against a very strong prior year quarter with organic growth of plus 9%. This reflects the continued strength of IQOS as a step-up in pricing, but was partially offset by expected HTU inventory movement, which I will come back to.

This organic figure does not include the excellent plus 14% ex currency top line growth of Swedish Match led by ZYN. Our total reported currency-neutral net revenue grew by plus 9.6%, with combined pro forma adjusted net revenue increasing by around plus 4%, also excluding currency. Our total organic net revenue per unit grew by plus 4.4%, with strong combustible pricing of plus 7.4%, partially offset by HTU dynamic in Japan and Germany, which I will come back to momentarily.

We delivered Q1 adjusted diluted earning per share of $1.38, well above our previous expectation. This reflect a strong underlying delivery from our existing operations, excellent Swedish Match performance and favorable phasing on interest costs. Compared to a record high prior year quarter and with a number of one-off or accentuated margin headwind from inflation, supply chain efficiency and timing factors as flagged previously, our adjusted diluted EPS contracted by minus 4.4%.

Let me now walk through the mechanics of our Q1 net revenues. We delivered overall adjusted net revenue growth of plus 4.6% on an organic shipment volume decline of minus 1.1%. What was included in this number, Swedish Match smoke-free volume grew by an excellent plus 10%, adding impressive accretion to our overall growth profile. Combustible and HTU pricing, excluding Germany and Japan HTUs, contributed plus 5.3 points of growth, including positive HTU pricing in a number of markets.

This was partly offset by a negative 1.3 point HTU impact from Germany and Japan. The larger of the 2 was Germany, reflecting a full quarter of the 2022 excise tax increase for which we await a court ruling later this year. In Japan, the October 2022 excise tax increase and transition to ILUMA were also a drag on our top line, and we expect some of this impact to phase out in the second half. While the increasing mix of HTUs in our business at higher net revenue per unit continues to positively impact our performance, lower shipments in Europe this quarter due to wholesaler and distributor inventory movements limited the benefit. This was also the main driver for the difference between our smoke-free organic net revenue growth and HTU shipment volume growth.

We expect this positive mix shift to accelerate as both smoke-free organic net revenue growth and HTU shipment growth align more closely with offtake trends for the year as they also did in 2022. The positive mix impact of HTUs, overall volume growth and pricing are powerful drivers of our transformation and growth. As expected, the first quarter was impacted by peak margin headwinds at both the gross margin and adjusted operating income level.

Our gross margin contracted by 0.6 percentage points due to the net impact of COGS inflation, pricing, volume, mix and productivity savings. We expect the positive elements of pricing, productivity and favorable HTU category mix to increasingly compensate and ultimately outweigh inflation as we progress through the year. Supply chain disruption and the accelerated transition of consumers and our business to ILUMA accounted for a further 0.6 percentage point impact.

We anticipate these items to abate as we progress with ILUMA launches and gain efficiencies in our supply chain, including a return to sea freight. In addition, specific cost phasing and the geographic mix of inventory movement, notably for HTUs in Europe, impacted our gross margin by 1.8 percentage points in the quarter. Despite these exceptional Q1 dynamics, we continue to forecast the full year 2023 margin impact of our heat-not-burn business to be favorable as inventory movement and ILUMA-related factors dissipate.

Therefore, and as explained previously, we expect a progressive improvement in our gross profit and OI margin notably weighted towards H2 as headwinds subside and the underlying driver of our transformation accelerate. At around 26% of adjusted net revenues, our Q1 SG&A costs are at a similar ratio to the full year 2022. However, as expected, there was a notable increase compared to Q1 2022, given lower commercial spend at the beginning of last year, the inflationary environment, cost phasing and front-loaded commercial investments.

Our successful cost efficiency programs continue to deliver, enabling ongoing investment and helping to mitigate inflation with $150 million of gross savings realized in Q1, of which almost $50 million were from SG&A. Importantly, we expect a significant slowdown in SG&A growth to a level below the rate of net revenue growth for the remainder of the year, which will support OI margin improvements.

This brings me to the outlook for 2023. Our robust Q1 performance supports visibility on strong full year growth. We continue to expect plus 7% to plus 8.5% organic top line progression with a targeted acceleration in HTU shipment volume growth versus 2022. As detailed in this morning's press release, our other operating assumptions remain unchanged. And we remind you that our organic metrics do not include the contribution from Swedish Match for the large majority of the year.

Our updated full year adjusted diluted EPS forecast of $6.10 to $6.22 includes an estimated unfavorable currency impact of $0.30. Positive estimated impact from the euro and a number of other currencies are outweighed mainly by the weakness of the Japanese yen as well as the significant depreciation of the Russian ruble and the Egyptian pound. This range continues to reflect plus 7% to plus 9% currency-neutral growth and does not include any contribution from a potential favorable excise tax ruling in Germany, which we would expect to add around 3 points to our adjusted diluted EPS related to 2023 tax payment.

We continue to expect Swedish Match to be low single-digit accretive to our 2023 adjusted diluted EPS after financing and for an increase of around $200 million in our non-acquisition-related interest costs despite a relatively modest increment in Q1. As discussed at full year earnings in February, this year's bottom line results are expected to be notably H2 weighted. However, we expect our organic net revenue growth to already accelerate in the second quarter into the high single digit.

We forecast second quarter HTU shipment volume of between 30 billion and 32 billion, with adjusted diluted EPS in the range of $1.42 to $1.47, including an estimated unfavorable currency impact of $0.30. Looking ahead to the second half of the year, we expect close to double-digit organic top line growth and a return to margin expansion. Looking now at our full year forecast through a different lens. After the temporary headwinds in Q1, we expect very strong performance for the remainder of the year.

Despite ongoing margin headwinds and investment, we expect organic top line growth of plus 8% to plus 10%, improving margin with expansion in H2 and currency-neutral adjusted diluted EPS growth of plus 10% to plus 13%. This reflects the strong underlying driver of our transformation with IQOS and ZYN driving volume at a higher net revenue per unit, combined with stepped-up pricing on combustible.

Turning back to our results. Our HTU adjusted in-market sales volume grew by an estimated plus 16%, demonstrating continued strong growth momentum. HTU shipment volume of 27.4 billion units were towards the higher end of our forecast range, with growth of plus 10.4%, which was well below actual offtake trends as anticipated, due to distributor and wholesaler inventory movement. As implied by our full year HTU shipment forecast, we expect the rate of shipment growth to accelerate for the rest of the year as shipments convert with consumer offtake and to grow at a faster pace in 2023 than in 2022.

Before detailing this inventory impact, it is important to note that in certain markets, such as Germany, IMS sales volumes are not measured at the point of distributor sales to the retail trade as the data is not available. In these cases, we instead use our shipment as the proxy. This means that shipment fluctuations can impact both IMS volume and reported market share and may not be representative of offtake dynamic.

Given the volatility seen over this quarter and from now on, where there is a significant difference between estimated offtake performance and IMS data, we may choose to provide market share metrics based on adjusted IMS to better reflect offtake, where adjustments reflect the total estimated impact of distributor and wholesaler inventory movement. As you may note in the appendix to today's earnings release, this is the case for Germany this quarter where we also provide historical figures.

Coming back now to Q1. HTU shipment volume in several European markets were below consumer offtake. This is explained by the reversal of some inventory buildup at the end of Q4 2022 to meet the needs of ILUMA launch, as mentioned at our full year results in February, and also to create some safety stock to mitigate the risk of production and distribution constraints due to energy shortages.

As anticipated, we were able to adjust the safety stock in Q1 as the risk receded. We also decreased the level of IQOS blade HTU inventory in several markets to reduce the risk of upside stock, given the rapid transition to ILUMA. Notably, impacted markets include Italy and Germany, where underlying market share and offtake trends remain strong.

Italian Q1 in-market sales volume grew by plus 21% compared to the prior year, with market share increasing from 15.4% in Q4 to 17.4% in Q1. In Germany, adjusted Q1 IMS volumes increased over 30% from the prior year, with adjusted market share up from 4.7% in Q4 to 5.3% in Q1. Now turning back to the overall picture, while total Q1 cigarette and HTU shipment volume declined by minus 1.1%, our total IMS volumes were essentially stable and grew excluding total estimated inventory movement.

Our cigarette shipments declined by minus 3.1% with resilient trends in many markets. The decline includes a notable impact from a high prior year comparison in Japan and the introduction of an abrupt excise tax increase in Pakistan, resulting in an increase in illicit trade and an industry contraction of over 30%. Volumes also declined in the Philippines following industry pricing with consumer purchasing power facing ongoing pressure.

We continue to target stable to positive combined cigarette and HTU shipment volume for the year following growth in 2021 and 2022. This notably does not include the excellent growth prospects of oral nicotine for which shipment volume grew by plus 10% in Q1. Most importantly, the exciting growth combination of IQOS and ZYN presents an unrivaled platform for growth over the coming years.

Focusing now on combustible, our portfolio delivered robust Q1 organic net revenue growth of plus 3%. This reflects strong pricing of plus 7.4% with a step-up across many markets, including Germany, Indonesia and the Philippines. With over 80% of planned 2023 combustible pricing implemented or announced, we have good visibility on the full year delivery, although some of the positive Q1 variance reflect earlier pricing compared to 2022. We now forecast a full year variance of plus 6% to plus 7%.

Our cigarette category share declined by 0.3 percentage points in Q1, which was essentially all attributable to geographic mix as the total industry decline in large volume markets, such as the Philippines and Pakistan. The impact of share movements within market was neutral with gains, including Egypt, Poland and Turkey, offset by decline in markets such as Ukraine, the Philippines and Iraq.

Importantly, we continue to target a stable category share in 2023 and over time despite the impact of IQOS cannibalization. Moving now to our smoke-free product. We estimate there were 25.8 million IQOS users as of March 31. This represents growth of close to 1 million adult users since December, with notable progress in Japan and Europe, in addition to a broad range of other geographies. IQOS ILUMA has been a positive catalyst for volume and share growth across a broad range of launch market, both supporting our strong position in the heat-not-burn category with a super user experience and fostering further category growth.

For existing IQOS users, ILUMA drives an accelerated upgrade cycle. This enhances retention and full conversion for the future with a temporary margin impact from concentrated device sales. Indeed, we are now approaching an estimated 10 million ILUMA users with ILUMA taking over 85% of HTU volume in the first launch market of Japan, Switzerland and Spain. ILUMA is also enabling better acquisition and conversion of legal age smokers with market share acceleration visible in both earlier and more recently launched markets, such as Italy and Korea.

Since the introduction in these 2 markets in Q4, we are seeing encouraging trends in initial launch area and expect this to be increasingly visible at the national level over time as it is in Japan and Greece after a seasonal inflection in the latter. Our main focus in Q1 was on ensuring the success of ILUMA in the 16 markets launched by the end of 2022, which cover over half of our IQOS business by volumes. In addition, we launched ILUMA on a limited basis in Indonesia in February via our IQOS Club Member program.

This IQOS Club was introduced in 2019 and now has over 100,000 estimated users across 10 cities with a notable boost from the launch of ILUMA. We expect to progressively launch ILUMA in more markets this year. With ILUMA accelerating IQOS growth were launched, PMI HTUs continue to strengthen their position as the second largest nicotine brand in markets where IQOS is present with a record high share of 9% in Q1.

Impressively, as of Q1 PMI HTUs are now the #1 nicotine brand in 10 markets with the addition of Italy and Greece during the quarter. Focusing now on Europe, which under our new regional structure include additional markets such as Ukraine, our first quarter HTU share increased by plus 1.7 points to reach 9.2% of total cigarette and HTU industry volume adjusted for estimated wholesaler and distributor inventory movement, such as those I mentioned earlier in Germany and Italy.

On the same adjusted basis, IMS volume continued to grow sequentially and reached a record high of 11.1 billion units on the 4-quarter moving average. This reflects strong progress across the region. We expect our Europe HTU volume to grow strongly in the remainder of the year, while as in the past, our quarterly HTU share of market can be impacted by seasonality of cigarette consumption during Q2 and Q3.

To give some further color on our outstanding progress in the region. Slide 16 shows the selection of the latest key cities offtake share. The success of IQOS continue across a diverse range of geographies from Western, Southern, Central and Eastern Europe, including markets with and without ILUMA. Notable standout include Budapest with over 35% offtake share as well as Rome and Athens reaching the high 20s. To my earlier comments, we are very pleased with performance in Germany, where offtake share in Munich surpassed 10% for the first time. We are also encouraged by recent positive regulatory developments in Greece, where the Ministry of Health approved differentiated health claim for heated tobacco product. Greece is the first country outside of the United States that permitted health-related statements following a robust scientific assessment.

In Japan, the heat-not-burn category now represents over 35% of total tobacco with IQOS driving category growth. The acceleration seen in recent quarters continued in Q1. Adjusted total tobacco share for our HTU brands increased by plus 3.4 points to 26.2%, with offtake share surpassing 32% in Tokyo and 30% in Sendai. Adjusted IMS volume again grew sequentially, reaching a record high of 9 billion units on the 4-quarter moving average.

Strong performance in Japan further highlight the importance of continuous innovation and a broad consumable portfolio. Our premium priced TEREA HTUs and mainstream price SENTIA HTUs continue to grow through Q1, strengthening their position as the 2 largest heat-not-burn brand. We are delighted with the progress in Japan. And as we look forward to further robust volume growth in the coming quarters, we would also like to remind you of the seasonality impact on quarterly share metrics.

In addition to stronger IQOS gains in developed countries, we continue to see very promising growth in low and middle income market, which are now approaching 30% of our total HTU volume. This slide highlights the selection of Q1 key city offtake shares across markets in Eastern Europe, the Middle East, Asia and Latin America. Notable successes include Bulgaria with offtake share of over 16% and Egypt, where offtake share in Cairo reached 7.5%. We also continue to see robust offtake volume growth across these important future markets.

Now moving on to Swedish Match business, which delivered an excellent Q1 performance with currency-neutral net revenue growth of plus 14% and smoke-free product comprising 77% of total net revenues. Most impressive was the continued outstanding performance of ZYN in the U.S. with plus 47% volume growth to 73 million cans. While volume growth benefited from inventory movement, including restocking in California following the December flavor ban, underlying growth in volumes was very strong, estimated well above plus 30%.

We are also pleased with the Q1 performance in other U.S. smoke-free categories, including moist snuff, which gained plus 0.8 percentage point category share and delivered shipment volume growth of plus 3%. The smoke-free category in Scandinavia continued to grow, driven by nicotine pouches, albeit at a slower rate following January's new excise tax increase in Sweden and Norway with destocking accentuating the volume decline for Swedish Match premium skewed portfolio.

In cigars, the business delivered positive pricing and robust shipment volume growth of plus 4% in a declining category, driven by the strong development of natural leaf varieties. Finally, I would like to congratulate Swedish Match employees for continuing to deliver excellent results as we thoughtfully integrate our activities. The integration is progressing very well, and we look forward to sharing more on our combined growth plan later this year.

Now let's examine ZYN's recent U.S. performance in more detail. Super progress continued with a record increase in 12 months rolling shipment volume of 23 million cans, which equates to plus 40% growth. Category volume share remained essentially stable, despite continued heavy competitive discounting from less premium offerings. Importantly, retail value share for ZYN also remained strong at 75.6%, highlighting its premium positioning and superior brand equity.

There are 2 key engine driving the U.S. growth of ZYN as covered at CAGNY. First is a progressive increase in distribution with a number of stores plus 13% higher than Q1 2022 at around 140,000. There remains ample opportunity to further increase this over time. Second, our velocity or the number of cans sold per store per week, ZYN velocity is going to grow sequentially and by an impressive plus 21% compared to prior year as the brand continued to resonate with adult nicotine users.

Now let me update you on our exciting plans to further accelerate our smoke-free journey. As previously mentioned, the full global rollout of IQOS ILUMA is a major priority. We are on track to make substantial progress this year as HTU manufacturing constraints continue to ease. We continue to work on our IQOS U.S. commercialization plan for launch in Q2 2024 in line with the principle outlined at the recent CAGNY Conference.

With the benefit of the expertise and commercial tools from launching IQOS successfully in over 70 international markets and the U.S. market with a clear regulatory framework and the ability to communicate with adult smokers, we remain very positive about the opportunity. Importantly, we believe we can make the necessary investment in the U.S. business, generating additional top line performance while continuing to deliver strong bottom line growth for PMI during the investment period.

In addition to our premium offerings, we are continuing to focus on BONDS, our latest heat-not-burn innovation, that is especially relevant for low- and middle-income consumer. Pilot launches in the Philippines and Colombia are progressing well, and we intend to continue taking the learnings from this market before deploying on a wider scale. Another key midterm opportunity from the Swedish Match combination is the international expansion of nicotine pouches, notably within the world's leading brand.

At CAGNY, I mentioned we are targeting up to 10 launches or relaunches this year as we look to develop the category with adult smoker who value the convenient, specific use occasion, test and satisfaction. We expect this to commence in a few markets this summer, including both developed and emerging countries. While staying clearly focused on the heat-not-burn and nicotine pouch category, which present the largest and most accretive growth opportunities, we are adjusting our VEEV e-vapor portfolio approach. We intend to focus on commercializing in select markets and prioritizing profitability, given the known category challenges.

VEEV 1 is a new pod-based system providing an enhanced user experience with fully outsourced manufacturing of devices and consumables to optimize cost. VEEV 1 will replace the current VEEV product. And as a result, we no longer intend to file a PMTA for the former technology. Instead, we will focus our near-term FDA engagement on IQOS and ZYN. We will come back on future e-vapor FDA authorizations in due course.

For this possible, the fastest-growing e-vapor segment, we are rebranding VEEBA to VEEV now. All of our e-vapor product will now be under the single recognizable brand VEEV for a seamless consumer experience. We will introduce a new VEEV 1 platform in Canada later this month and will apply an agile and disciplined approach for further VEEV rollout later this year.

Moving to sustainability. I want to first draw your attention to our 2022 integrated report published earlier this month, which outlines the progress we are making towards achieving our purpose and smoke-free future. The report provides a comprehensive run-through of all our most material sustainability topic. This includes those in focus for investors such as post-consumer waste, use access prevention, decarbonization and our resource allocation towards advancing our smoothly transformation.

In conjunction with the integrated report, we also published an updated ESG KPI protocol, providing even more robust criteria on how we define success and measure ESG performance. It focuses on the KPIs included in our Sustainability Index, which, as outlined in our 2023 proxy statement, continue to represent 30% of our long-term performance-based equity executive compensation.

I am also proud to announce that we released our first TCFD report yesterday, which updates and comprise our previous disclosure on how we are implementing the recommendation of the task force on climate-related financial disclosures in 1 document. This will be an important topic for many companies as reporting regulations evolve. Lastly, we are also pleased that following CDP's AAA recognition, PMI was again included in CDP's Supplier Engagement Leaderboard, contributing towards achieving our Scope 3 ambitions.

To conclude today's presentation, we are on for a strong performance in 2023, despite margin headwinds. Our underlying growth fundamentals remain strong, and we expect these headwinds to progressively ease through the year. Indeed, we delivered higher-than-expected Q1 results, which put us on track for the third consecutive year of high single-digit organic net revenue growth. Continued excellent IQOS and ZYN performance further enhances our position as a global smoke-free champion with leadership position in the largest category of heat-not-burn and the fastest-growing category of oral nicotine.

We are taking actions through pricing in combustible and our cost-saving initiatives to recover cost inflation as we progress rapidly towards our ambition to become the majority smoke-free business. Finally, we remain a highly cash-generative business with an unwavering 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 extremely happy to answer your questions.

(Operator Instructions) We'll take our first question from Bonnie Herzog with Goldman Sachs.

So I guess I have a question on your guidance as it relates to Q2. It does now seem to be a bit lighter, implying a lot more of the growth is now expected to be in the back half. So just trying to get a sense of how conservative your Q2 guide might be amend. Really, Emmanuel, how much visibility and confidence you have that your business really can accelerate and outperform in the second half? Maybe you could highlight for us some of the key puts and takes that give you this confidence and maybe where you see the greatest potential upside. And also give color on this?

Okay. Not, sure, Bonnie. Happy to do that. And I guess -- thanks for the question because that helps me clarify certainly the phasing of the profit generation this year. I think we're not coming with any different message from what we said back in February. We always said that we would be facing in the first half of the year a number of headwinds on profitability that there would be some inventory movement playing. We highlighted that, and we clearly said there will be margin improvement coming in the second part of the year.

And we are coming today exactly with the same message. We are pleased to have a Q1 that is above our initial expectation. We never gave a guidance until today on Q2. But I think what we are seeing today on Q2 is coming with a lot of positive. We are explaining that we do expect an acceleration of the top line. We are talking about high single-digit growth that we are targeting for the second quarter.

And that's, of course, going to be a very nice contribution to the performance in the second quarter. That is highlighting the momentum that we have on the business that we see behind IQOS that is not capturing the ZYN growth for the second quarter. So ZYN is just coming in addition to this organic growth. So I think it gives an idea of how nicely up and running and dynamic is our business.

Now in terms of margin, it is true that, again, in Q2, we're going to have a number of headwinds and notably at the level of the gross margin. So we're going to continue to have a number of impacts coming from inflation. This is going to be progressively corrected, but I think you should expect another quarter with gross margin rate declining in a material manner versus 2022.

And then the second part of the year will be showing improvement, again, in line with our initial thoughts, where, I guess, you're going to start seeing in terms of margin evolution, some more positive impact. This is on the revenue -- sorry, SG&A to revenue ratio where we have seen a deterioration in Q1. I think -- I'm not saying that we will have SG&A growing at a lower pace than revenue in Q2, but I expect the growth of SG&A in Q2 to be closer to the revenue, and therefore, that will weigh less on the operating income margin.

But that's really what you should expect in terms of sequence for the year. Again, we expect very nice acceleration for the top line, just confirming the nice momentum that we are experiencing in the business. And we have this ramp-up on the margin that is coming progressively, it going to show up first at the level of the SG&A on revenue. And in H2, we are expecting, as we said, a better evolution of the gross margin rate. So far, we're just confirming initial expectations.

No, that's super helpful. And just sounds like you've got some pretty good visibility. So that's -- yes, definitely helpful. And then I guess just maybe a quick high-level question on the health of the consumer in sort of your key markets, if you could kind of touch on that for us. And then in the context of that, you've certainly been putting in stronger combustible cig pricing. So just love to hear a little more color on how the consumer has been responding to those actions and really how confident you are that you're going to be able to continue to push through that pricing for the remainder of the year.

Yes. Well, I'm not going to say that we don't see any pressure on the consumer in the world. It is quite obvious. And of course, I'm not talking about the U.S., which maybe you could deserve a separate comment. But it is clear that in countries such as the Philippines, for instance, we see some impact on the business coming from purchasing power. I think we see some of that as well in Indonesia. So there are markets where there was already some pressure on purchasing power, possibly leading to some down trading and that has continued to play as we progress through the beginning of 2023.

But I have to say that in many markets, we haven't seen clear signs so far. We have to stay very cautious, of course, of pressure on the consumer or massive down trading. We don't see that. The Marlboro market share was a bit down, but I don't think that is clearly reflecting at that stage a pressure on the premium part of our portfolio. And we've been increasing prices, as you have seen in a very significant manner. Of course, competition not immediately or not totally responding to our price increase that can have an impact on our market share. But I would say, so far, we have the feeling that in a highly inflationary environment, the consumer is taking as normal and is not seeing as an issue to see also price increase on this tobacco product.

We'll take our next question from Gaurav Jain with Barclays.

So the first question I have is on FX. So in Feb, you had guided for a $0.15 headwind. Now it is $0.30, Egyptian pound had depreciated by Jan. And then, yes, yen has gone down a bit, but euro, which is a much bigger currency for you, is up also a bit more than that. So ruble can't be that big, right? Or is it becoming bigger this year versus last year? So could you just help us explain the FX.

Yes, Gaurav. So I think you rightly pointed to the ruble. Actually, if you are not going to disclose currency by currency, but if you look at the ruble, just the ruble is more than the net impact of $0.30 that today we are anticipating for the year. So I think it shows a very strong impact of the ruble. And the Egyptian pound continue to devaluate after January. So it's -- I'm not sure we had the full impact of the Egyptian pound.

And actually, if you accumulate ruble and the Egyptian pound, you have 80% of the net impact of $0.30. It's a net impact. Don't get me wrong because you have also the yen that is quite negative. And then you have the euro and a number of other categories that is positive. But I think with the ruble and the Egyptian pound, you have a pretty good explanation of the net impact. I hope it's helpful.

Okay, sure. And second, the U.S. cigarette volumes industry level are quite weak, minus 9%. And then looking at the European data that you shared, it is -- the industry volumes are flat on what were already very strong comps. And the reasons what have been mentioned for the U.S. industry weakness, which is macro, weak consumer, stimulus payments going off, disposable e-cigarette growth, I could apply the same logic to EU consumer, EU smoker and still the volumes are so much better than trend. So is there a -- can you explain like why are the U.S. smoker and EU smoker, why are they behaving so differently?

Gaurav, I cannot -- and I will have to consider that I'm not the greatest specialist of the U.S. consumer for combustible cigarettes. So I wonder myself to give an analysis. I think it's in line with my previous comment on the fact that so far, we have been a pretty good resistance from the consumer to same price increase and coping with inflation in Europe. I'm not able to tell you why there is a difference here. We know that the social model in Europe is different. You may have some more protection, some more safety needs that are playing and maybe limiting the impact of inflation.

There was maybe more compensation given from various government on trying to fight again energy price increase and sometimes compensating of agricultural product inflation across a number of geographies. So that can be one element to explain why the European consumer is resisting better. But I'm not going to pretend that I have the perfect answer to your question.

And we'll take our next question from Pamela Kaufman with Morgan Stanley.

I was hoping that you could elaborate a bit more on your SG&A investment for this year. What are the key areas that you are investing behind and the step up in that investment in Q1? I guess how much of this reflects structural increases in inflation driving higher costs versus incremental investment that you're making behind ILUMA and your Health and Wellness and Swedish Match businesses?

Again, I'm going to try to go as far as I can, as you can imagine, some of that is super sensitive, so we're not going to share in detail what we are investing and where. First of all, trying to give you perspective for the full year. We believe we're going to have our SG&A growing faster than revenue organically. But nevertheless, we expect a limited discrepancy between the two. So that means that as we progress through 2023, you should expect the growth of our SG&A to converge with the top line growth. I'm speaking here organic.

And Q1 is really, I would say, impacted by a number of one-off both, by the way, on the basis of comparison, if you look at our Q1, Q2, Q3, Q4 numbers last year, sequentially, you will see that Q1 was very low, both because we did not invest at the same moment of the year. So there is a phasing in investment and also because there was some one-off positive last year. So don't take Q1 as a reference.

Having said that, we are facing inflation, of course, in our SG&A. It's a lot of people cost. And of course, we are increasing salaries. But we're also indeed generating some efficiency. So that is giving us some leeway to invest on our priority. It's about, of course, commercial investment on our priority, as you can expect. So it's everything on marketing commercial to boost IQOS. That is, of course, a big driver. It is the investment that we are making to prepare the U.S. We talk about the investment that we are making in Wellness and Healthcare.

We continue to innovate a lot. We have innovation in the pipe for all our smoke-free product. And of course, that is also having some impact. So that is really what is driving this growth, and we continue to see as important this capacity that we have to cope with inflation, to invest for the future and at the same time, to have an SG&A evolution that thanks to the dynamism of the business is allowing us to still generate nice operating income and net profit growth. That's what I can share with you.

Okay. And then can you talk about your change in your e-cig strategy? What prompted your strategy towards IQOS VEEV? And how are you thinking about the category over the long term and your participation in it?

Look, I think we've already been clear that while we were clearly developing some offering on the vaping category, this was not our priority. We had IQOS. And now I would say we are even more taken by 2 priorities, which are IQOS and ZYN. When you have such a fantastic team and the potential that they have to deliver very strong top line growth, volume growth, revenue growth and in a very nicely profitable fashion, that's really the priority.

I guess you listened to us at CAGNY and we expressed the questioning that we have on the vaping category today, which are around the absence of clear regulation in many countries. The fact that, that is giving way to an appropriate marketing activities, risk of underage consumption. And also the fact that this is a category where so far it's difficult. I'm not saying impossible, but difficult to see a lot of profitable model being developed. And therefore, that is pushing us to look at that and continue to work on this category and the fact that we are coming with this evolution of the range, I think, is just in line with the fact that the technology is evolving. We see the customer needs evolving as well. That's why we are developing VEEV now.

But we're going to be focused. So it's not going to be across geography. It's going to be where the vaping category is relevant. It's going to be where we have a differentiation, where we have the commercial strength to make an impact. And I think it is a much better strategy to do that, develop a few successes instead of exhausting ourselves in trying to develop something global today, when we don't see necessarily the ingredient of the driver for that to happen in an interesting manner, both in terms of growth, top line and bottom line progression.

And we'll take our next question from Vivien Azer with TD Cowen.

So my first question is a follow-up to Gaurav's, please. In terms of your current FX outlook, does that contemplate another devaluation of the Egyptian pound because my understanding is that's pretty well expected at this point?

So it does not because, of course, we don't have any idea of what it could be, when it could happen. So these are really an average that we take on the spot in the day before the announcement and not taking any kind of forward-looking or whatever consensus for currency evolution. You have a lot of people today that believe that the euro is set for a nice wide against the dollar in the coming months. Frankly, we're not betting on any kind of possible evolution, but really just working on the spot.

Okay. That's fair. I understand you're not in the business of predicting currency. It just seems like this is tied to the IMS bailout. So it seems reasonable to that. My follow-up question then is on the Swedish Match margins, which came in quite nicely. I was just curious, given the incremental inventory benefit that you saw in California, like how should we think about the 1Q margin in context of a normalized margin? Was there an incremental margin benefit that we should be backing out mentally as we think about what the appropriate level of profitability is for that business?

Well, Vivien, I think what I can share with you is that I believe Q1 is just the bright confirmation of what we said, i.e., Swedish Match is coming with a very nicely accretive impact to the PMI growth. It is true for the volume, it is true for the revenue, and it is true for the profitability. So indeed, ZYN growing in the U.S. very nicely, and I don't come back on this north of 30% growth without the impact of California. That is driving a business that is nicely profitable, that is itself accretive to the Swedish Match average business. And therefore, of course, to PMI.

And it is just very good news to have this engine for growth. Frankly, I mean, I don't want to repeat myself, but IQOS and ZYN together, that just a very exciting pair, and ZYN is coming as a very nice top line and margin enhancement role, and we expect that to continue.

And we'll take our next question from Andrei Condrea with UBS.

Two from me, please, if you don't mind. Firstly, on the input cost inflation side of things. Obviously, your ILUMA margins will have efficiencies coming online later this year. But in terms of the other headwinds you flagged, leaf and acetate tow is there any color what you can give on just how big these headwinds are?

Well, they are very material, but we flagged that. And I think once again, we explained that in Q1, and we expect that to continue in Q2. This big increase in energy price, leaf price, acetate tow is going to be the biggest driver for the pressure on the gross margin. Now as we enter the second half of the year and notably towards the end of the year, we believe that these elements will be -- well, first of all, will be facing already with some of the bad news in H2.

So of course, the period-on-period comparison will be, of course, easier. And then we keep working on productivity. We may keep working on our COGS to see all optimization. So this negative pressure, I'm not saying is going to disappear, but it's going to ease versus what we are experiencing in H1. But I would expect in Q2, the pressure to remain very strong at that level.

That's very clear. And my second question is a bit more long-term. Obviously, we saw one of your peers come out with a new product at the Investor Day for the nicotine pouch space for the U.S. And at the same time, your other peers bringing the European product in. Is there a scope for a similar innovation for ZYN, given the criticism -- well, rather than drawback it has -- it being of a much drier product versus the European counter parts.

Yes. I believe that with Swedish Match, we have the biggest specialist, super-focused, knowledgeable player of the oral nicotine category. So we've been adding to that amazing skill, the 13 -- you may remember that we bought this company that is specialized in formulation of product some of them, including nicotine, and that can also come with very nice innovation in the form factors. So you should expect us. Of course, don't expect me to come down with detail, but you should certainly expect us to come with nice innovation.

There is certainly the appetite in some area from the consumer to try new things, new reduced risk product to develop this oral nicotine category in other spaces, probably the consumer doesn't know as well what can be done. So it's for us, it's our duty to come and make some proposal. But I guess you can expect us, and I think we demonstrate that PMI and now in the PMI per Swedish Match to be leading innovation in this category as well in the future.

And we'll take our next question from Matt Smith with Stifel.

The incremental number of IQOS users stepped up in the first quarter to about 900 million additional users on a sequential basis. Can you provide more details regarding the favorable conversion trends you've seen behind ILUMA? And should we expect IQOS user growth to accelerate in the second half as ILUMA capacity improves and you expand the geographical footprint of the product?

Thank you. So yes, we are close to 1 million additional IQOS user in Q1. It's a nice number. It's not something that we cannot beat. I think that there is opportunity to further accelerate as we continue in Q2 and beyond. But first of all, I would like to have a few words of cautiousness. It's not a scientific number. That's an estimate, and that can have some variation depending on the number of elements. But I think, directionally, it is correct, and I think it shows the very strong momentum of IQOS. It is confirmed, of course, by the consumer offtake that we've been describing.

It is clear that ILUMA is helping this conversion. So what we see with ILUMA is a higher capacity to convince smokers because it is a more seamless experience. There is no cleaning. It is mimicking even closer the ritual of the combustible cigarettes. The overall experience is more satisfying. So the abandonment rate is lower. And of course, we talk about net user acquisition, so that is also helping. We have very nice progression of the consumer satisfaction in all countries.

That is, I guess, probably supporting the lower abandonment. So it is clear that the more we go for ILUMA, the more we are in the capacity to accelerate conversion. Japan, I think -- yes, I mean we're coming with a number in Japan and you can build the history. I think Japan is providing a lot of interesting information because it took some time. I mean the acceleration that we have since Q3 in Japan is quite spectacular, frankly, and probably goes beyond our expectation. But it shows that ILUMA is probably -- gradually getting traction with, I don't know, it's a word of mouth.

And -- but the consumer is realizing that this is making a big impact. And frankly, the acceleration of the market share to north of 26%, and I'm not talking about Tokyo, but average Japanese market share is a significant acceleration. It started in Q4, but it accelerated, and it's 1 year after the launch. So it shows that not everything is happening in the first quarter of the launch. I think we're showing a number of chart here showing that. And that bodes well for a nice ramp up in the coming quarters as not only do we have to start to launch ILUMA in a number of countries, but we know that this positive effect will spread over the coming quarters. So we take that as a nice driver for user acquisition growth in the coming quarters.

And a follow-up on a comment you mentioned on the call about maintaining profit growth in the U.S. as you launch IQOS. Can you talk about the investment needs in the U.S. to support commercialization? And how the $75 million or so of investment here in 2023 against this begins to build out the infrastructure necessary for a broader IQOS launch?

Yes. Well, that's the additional investment. But of course, we are already starting with some investment in the U.S. We'll come at the time of the Investor Day in September with detailed plan on how we intend to grow IQOS in the U.S. And at that time, of course, we share much more color on the level of investment that we believe is going to be necessary. I think the important message because we have a lot of questions here is the fact that, yes, of course, in order to express what we think is a great potential of IQOS in the U.S., investment will be needed.

By the way, we've been investing to build this phenomenal business for IQOS in Japan and Europe. I mean we've been investing. It didn't come by chance. So we will invest in the U.S. But what we are seeing is that, given the growth momentum that we have in the business, we think that investing in the U.S. behind IQOS will, first of all, provide even more momentum on the top line and that we can absorb this investment while continuing to grow the bottom line very nicely.

We're not ready to compromise on bottom line growth because of investment that we need to make in the U.S. If I want to repeat something that I said already, I think the question mark will be, what is the differential that we can generate between top line growth and bottom line growth? Remember, the last algorithm was 5% and 9%, above 5%, above 9%. Well, if we increase more than 5% the gross rate perspective, it doesn't mean that we're going to keep a 4 points of difference between top line growth and bottom line growth. That's the sense of the comments. I hope it's helpful.

And we'll take our next question from Jared Dinges with JPMorgan.

I want to ask about ZYN growth in the U.S., which seemed to actually accelerate in the offtake data, despite the base continuing to grow, and it's actually pretty sizable now. Do you think there's any benefit there from the investments that you started to make as part of your IQOS preparation in terms of building out maybe a sales network? Are you also increasing SG&A investments in ZYN alone? I'm just thinking of this in the context of the brand is getting bigger, we're seeing the cigarette data has clearly been very weak, but yet the trend continues to do very well. So just trying to understand what's really driving that?

Thanks, Jared, for the question. Well, first of all, yes, we are, of course, extremely pleased with the performance of ZYN in the U.S. And I want to pay a tribute to the work that the team is doing there, which is absolutely fantastic. No, I don't think that there is yet a sizable impact coming from our investment in the U.S. I think it's being developed on the merit of the great commercial plan and action. The brand has amazing traction. I think that it's extremely highly regarded by the consumer premium brand, a very nice franchise.

And they are building on these 2 drivers, as explained, 1 geography. The other one is consumption per store. We just show that two things. One, of course, we have enriched the full geographical coverage. And that's where probably in the coming quarters, you will see some acceleration as we're going to put more feet in the street and more capacity to visit retail stores. And the other thing is that there is a growing knowledge, understanding and appetite for the category and for ZYN that epitomize the category, and that's what we are seeing.

So, so far, no really increased investment behind the natural increase when you have such a nice growth, of course, increase investment year-on-year. So we do increase investment in the U.S., but nothing kind of at the stage accelerated plan and not yet impact coming from investment on IQOS that should come in the future.

And we'll take our final question from Priya Ohri-Gupta with Barclays.

Emmanuel, I was hoping that we could touch on your cash flow performance in the quarter a little bit. It sounds like the weakness was somewhat related to timing factors because 1Q is seasonally your weakest. But if you could just walk us through sort of what the drivers for that negative cash flow from operations figure were that would be helpful?

Yes, absolutely. So indeed, Q1 has not been great in terms of cash flow performance. But that was, again, expected. That is linked with the timing of shipments, excise duty payment and some of the working capital. And there was nothing surprising. I mean, I would prefer to see higher operating cash generation in Q1, but that was expected. And we are absolutely confirming the objective for the year of an operating cash flow between $10 billion to $11 billion.

Okay. And then just a housekeeping item. Can you give us the pro forma leverage, including the benefit of Swedish Match, for a full year versus the reported numbers that were in the release?

No, I don't think it was in the release. I don't know whether we'll communicate that. But I mean, you can come to it. I'm not sure to understand fully what your question was. I think you have the data to calculate things, but you can come back to us and we'll see whether we can show where the information is available.

Sure. I think that the sequential increase in leverage, if you put in a full year's benefit of Swedish Match, just closer to about 0.2 of a turn versus a very higher figure that was reported directionally, right?

No, I think you're alluding to the fact that we concluded 2022 saying, well, we are around 2.9x, but of course, that would be lower and significantly lower. And maybe about what you are seeing here, if you were to take the full year of Swedish Match.

And there are no further questions at this time. I'll turn the call back over to the management team for any closing remarks.

Thank you all for joining today. That concludes our call. If you have any follow-up questions, please contact the Investor Relations team. Thank you again, and have a great day.

Thank you all. Talk to you soon. Thank you. Bye-bye.

Thank you. And this does conclude today's program. Thank you for your participation. You may disconnect at any time.