Earnings Call Transcript - PM Q2 2021

Operator, Operator

Good day, and welcome to the Philip Morris International Second Quarter 2021 Earnings Call. Today's call is scheduled to last about 1 hour, including remarks by Philip Morris International Management, and the question-and-answer session. Media representatives on the call will be also invited to ask questions at the conclusion of questions from the investment community. Now I'll turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Nicholas Rolli, Vice President of Investor Relations and Financial Communications

Welcome. And thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2021 second quarter results. You may access the release on www.pmi.com. 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, and additional heated tobacco unit market share data, are at the end of today's webcast slides, which are also posted on our website. Unless otherwise stated, all references to IQOS are to our IQOS heat-not-burn products. All references to smoke-free products are to our RRPs. Growth rates presented on an organic basis reflect currency-neutral underlying results. Adjusted net revenues exclude the impact of the Saudi Arabia customs assessments as described in today's press release. Please note that due to UK Takeover Code requirements, we do not intend to provide further information on this call regarding our offer to acquire Vectura Group PLC that has not already been disclosed in the Rule 2.7 announcement on July 9, 2021. A copy of the Rule 2.7 offer announcement is available on www.pmi.com. 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. Please also note the additional forward-looking and cautionary statements related to COVID-19. It’s now my pleasure to introduce Emmanuel Babeau, our Chief Financial Officer. Emmanuel?

Emmanuel Babeau, Chief Financial Officer

Thank you, Nick, and welcome ladies and gentlemen. I hope everyone listening to the call is safe and well. Our business delivered a very strong performance in the second quarter of 2021, coming slightly ahead of our expectations to match Q1's record high quarterly adjusted diluted EPS of $1.57 despite the continued challenges of the global pandemic. Most impressive was the continued strong growth of IQOS, which made up 13% of our volumes and nearly 30% of our adjusted net revenues compared to 24% in the prior-year quarter. HTU shipment volumes grew plus 30% and plus 12% compared to the same quarter last year and the previous quarter sequentially to reach 24.4 billion units with strong growth across key geographies. We also continued converting adult smokers at a good pace surpassing an estimated 20 million users, of which almost 15 million have switched to IQOS and stopped smoking. Combustible net revenues grew by plus 4% in Q2 on an organic basis, reflecting a partial volume rebound against a weak prior-year quarter and solid pricing partly offset by market mix. Our adjusted operating income margin expanded significantly in both the second quarter and first half overall, and while we expect commercial investments to step up in the second half, this puts us firmly on track for a strong 2021 performance organically with an expected currency tailwind providing additional growth in dollar terms. Importantly, this outlook also allowed us last month to confirm our share buyback program, where we target $5 billion to $7 billion over 3 years. We are also delighted to announce that IQOS ILUMA, the next-generation of IQOS, will be launched in Japan next month. As we covered at Investor Day in February, this represents a major step in category innovation as we seek to accelerate our journey toward a smoke-free future. With regard to long-term growth, we also took important steps to build our modern oral and Beyond Nicotine business in recent weeks through the proposed acquisition of Fertin Pharma and Vectura, which I'll come back to later. Turning to the headline numbers, our Q2 adjusted net revenue grew by plus 11.6% on an organic basis, or around plus 18% in dollar terms. This reflects both the recovery of the combustible business in many markets compared to the heavily disrupted second quarter of 2020, including the need for higher inventory levels and the continued strength of IQOS with plus 35% organic growth in RRP net revenue. For combustible, while certain geographies and channels remain significantly affected by the pandemic, notably in South and Southeast Asia, South America, and global duty-free, re-openings in much of the world have led to partial recovery in social occasion and a sequential recovery in our market share. We witnessed good organic growth of plus 5.1% in our net revenue per unit, driven by the increasing weight of IQOS in our sales mix and pricing on both combustible and RRPs. Our adjusted operating income margin increased by 270 basis points on an organic basis. This reflects the increasing weight and profitability of IQOS, higher combustible volume, the positive impact of pricing, productivity savings including lower device costs, and lower commercial spend due to the pandemic. Our resulting adjusted diluted EPS of $1.57 represent plus 17.8% organic growth and plus 21.7% in dollar terms, a very strong performance. Looking at the first half overall, our adjusted net revenues grew by almost plus 12% in dollar terms, and by plus 7.1% organically. This was achieved despite the tougher Q1 comparison and reflects the Q2 factors I just mentioned, and the consistent growth of IQOS where progress throughout the pandemic has been impressive, notably including the doubling of users in the EU region since the end of 2019. We delivered strong organic growth of nearly plus 6% in our net revenue per unit, again reflecting our shifting business mix and pricing. Our H1 adjusted operating income margin increased by 440 basis points on an organic basis. While we plan to increase commercial investments in the second half, as we noted at Q1, this remains an excellent performance. This brings me to guidance for 2021. We now expect an even stronger organic performance for the year than previously supported by improved total industry volume for combustible following the easing of pandemic restrictions. For net revenue, we are revising our organic growth forecast to between plus 6% and plus 7%, representing the upper end of the previous range. We continue to expect organic adjusted OI margin expansion of around plus 200 basis points, and we are raising our organic adjusted diluted EPS growth range to plus 12% to plus 14%, or plus 15% to plus 17% in dollar terms. We also continue to expect HTU shipment volumes of between 95 billion and 100 billion units. Given the strong momentum across our market, the need to maintain inventory duration and preparation for the roll out of IQOS ILUMA, which uses different consumables, we expect our full-year HTU shipment to be slightly ahead of IMS volumes. This projected organic EPS growth, including an estimated favorable currency impact of approximately $0.18 at prevailing rates, translates into an increased adjusted diluted EPS range of $5.97 to $6.07. This guidance does not include any material impact of share repurchase or acquisitions. We recently received Board authorization for the launch of our three-year share repurchase program where we target $5 billion to $7 billion starting in the period following our Q2 earnings release. Please note this program is not affected by the proposed acquisitions of Fertin Pharma or Vectura. Turning now to some of the key H2 assumptions underpinning the guidance. We assume that many of our key markets will have largely emerged from COVID restrictions, supporting better industry volume. Where significant pandemic-related challenges remain, notably Indonesia, the Philippines, and certain markets in South America, we assume no significant further deterioration from the present situation. We continue to assume no meaningful recovery in duty-free this year with Intercontinental and Asian travel still subdued. A rebound in travel within custom areas such as the European Union has limited effect. In addition, following combustible pricing of around plus 3% in the first half, we anticipate a somewhat softer second half progression. We continue to expect the full-year volumes to be plus 2% to plus 3%. This reflects continued pandemic-related challenges in certain market, notably in South and Southeast Asia. H2 also faces tough pricing comparison from the 2020 VAT reduction in Germany and new excise tax terms in Australia. The global semiconductor shortage continues to put constraints on device supply. And while the overall impact remains manageable, we have adjusted our device assortment to limit the effect on consumer availability. This dynamic is included in our guidance, and we continue to monitor the situation closely. Despite these factors, we have multiple growth drivers in our business, and we are confident in our ability to deliver continued robust top-line progress. This revenue assumption includes higher expected device shipments and the launch of IQOS ILUMA, which will contribute to less gross margin expansion compared to the first half. As mentioned previously, we will also step up our commercial investment in key areas, including portfolio expansion and product launches such as IQOS ILUMA and IQOS VEEV, smoke-free category understanding and awareness campaigns, and a number of commercial development projects. We anticipate around $300 million to $400 million of incremental spending, compared to the first half, which will impact our H2 OI margin, but overall, still expect to deliver a very robust expansion of around plus 200 basis points for the year. For Q3 specifically, we expect EPS of $1.50 to $1.55. Lastly, we continue to expect around $11 billion in 2021 operating cash flow at prevailing exchange rates and subject to year-end working capital requirements. Before discussing our results in more depth, I want to highlight some of the positive regulatory developments in the quarter. Recognition of the harm reduction potential of smoke-free products continues to gain traction. Examples in recent weeks include the passing of a broad, differentiated regulatory framework for RRP by the Philippines House of Representatives, and the institution of differentiated excise treatment for heated tobacco products in Pakistan. In Mexico, the ban on the import and export of Electronic Nicotine Delivery Systems no longer applies to heated tobacco devices, which will allow us to resume imports of IQOS devices. While we are encouraged that the German government has recognized the important principle of differentiation between combustible cigarettes and smoke-free products on the basis of potential health impact, we view the announced excise tax changes on heated tobacco as misguided, providing less incentive for consumers to switch away from cigarettes to less harmful alternatives. We also note the differing views among the key political groups in the country ahead of the fall election, and we are hopeful a new government could revisit the decision. In the EU marginarily, we remain optimistic that the revision of the tobacco excise directive will lead to greater harmonization in the scriptural approach to non-combustible products, taking into account the relevant good practices and experience gained by member states. Turning back now to our quarterly results. Q2 total shipment volume increased by plus 6.1% and by plus 1.1% for H1. This reflects continued strong growth from HTUs of plus 30% to reach 24.4 billion units in Q2, driven by the EU region, Japan, Russia, Ukraine, and encouraging progress from recently launched markets in the Middle East. HTU shipments were around 1.4 billion units ahead of IMS volume for the second quarter, reflecting the need to maintain inventory duration in the growing business, sea freight lead times, and the first shipment of ILUMA consumables. The plus 3.2% growth in our Q2 cigarette volume reflects the recovery of a number of key markets compared to a notably weak prior-year quarter when pandemic-related disruption was at its peak. While our cigarette share improved sequentially, we continue to face some specific market share headwinds in addition to market mix effects, which I'll come back to. Due to the impressive performance of IQOS, heated tobacco units comprised 13.3% of our total shipment volume as compared to 11% in the year of 2020, 8% in 2019, and 5% in 2018. We expect this proportion to grow over time as positive momentum on IQOS continues, providing a powerful driver of revenue and margin growth. Our sales mix is changing rapidly, putting us on track to achieve our aim of becoming a majority smoke-free company by 2025. Smoke-free products made up nearly 30% of our adjusted net revenue in the quarter and in H1, compared to 23% in H1 2020. IQOS devices accounted for approximately 5% of the $4.4 billion of RRP net revenues, reflecting longer replacement times and fewer second device purchases for existing users due to improving battery life, functionality and reliability, and lower device prices in certain markets as we prepare for IQOS ILUMA. The plus 7.1% organic growth in net revenue on shipment volume growth of plus 1.1% reflect the twin engines driving our topline. First is pricing on combustibles and in certain markets on HTU net of the lower device pricing I just mentioned. Second, the increasing mix of HTUs in our business at adjusted net revenue per unit continues to deliver substantial growth, and as explained at Investor Day, this is an increasingly powerful driver as our transformation accelerates. Let me now go into the driver of our first half margin expansion, starting with gross margin, which expanded by plus 340 basis points on an organic basis. This is driven by multiple levers, as explained in prior quarters, including the mix effect on HTUs and pricing across our portfolio. Our significant effort on manufacturing and supply chain efficiency are bearing fruit, more than offsetting the effect of combustible volume declines, with around $300 million of gross productivity saving delivered in H1. This represents a strong start on the journey towards our target of $1 billion over 2021-2023. This was accompanied by strong SG&A efficiency with our adjusted H1 marketing administration and research costs, 90 basis points lower as a percentage of adjusted net revenue on an organic basis. This reflects the ongoing digitalization and simplification of our business processes, including our IQOS commercial engine and more efficient ways of working. We delivered around $120 million towards our 2021-2023 target of $1 billion in growth SG&A savings before inflation and reinvestment. Focusing now on combustibles, we hold the leading international portfolio by market share and by brand strengths. This gives us a formidable platform to accelerate the growth of IQOS via our commercial infrastructure, industry expertise, and ability to communicate with adult smokers where permitted. It is therefore important to maintain our leadership through selective investment, as we also drive return through pricing and efficiency. Despite good results in markets like Mexico, Saudi Arabia, and Turkey, our Q2 cigarette share remained below the prior year, with over half of the share loss due to market mix, reflecting our high exposure to markets like the Philippines and low presence in certain emerging markets with strong rebounds, such as Bangladesh. Importantly, our share improved sequentially compared to the first quarter, and we expect this positive trajectory to continue through the second half. This reflects a partial recovery from the COVID impact on social occasions, where Marlboro over-indexes, border closures, and travel. However, the expected recovery is also supported by portfolio initiatives, including in the value segment and the enduring strength of Marlboro. We continue to target stabilization in our cigarette category share over time, with HTU gains coming on top. I will now turn briefly to the South and Southeast Asia region. As covered last quarter, after a difficult 2020, notably in Indonesia, volume headwinds have been moderating. However, the pandemic remains a major issue in the region, with renewed lockdowns in a number of areas. Daily consumption patterns are still below pre-pandemic levels, and the pricing environment remains challenging. We continue to expect volume growth in Indonesia this year as the industry improves, with encouraging recent share gain within the Tier 1 segment where we participate. Our overall share in both Indonesia and the Philippines was sequentially broadly stable in Q2, with our portfolio initiatives geared at further share recovery over the balance of the year. In RRPs, IQOS continued to grow strongly in Metro Manila with an exit share of over 1% for HEETS. For the region overall, we remain on track to deliver positive organic net revenue growth over the April to December period as outlined on our Q1 call. Moving now to IQOS performance, we estimate there were 20.1 million IQOS users as of June 30th. After the exceptional addition of around plus 1.5 million adult users in the first quarter, we added a further plus 1 million in Q2 and plus 2.5 million year-to-date, building on the step-ups in the second half of 2020. Our accelerated pivot to digital and remote engagement during the pandemic, combined with strong momentum for the IQOS brand, is paying off. We further estimate that 73% of this total of 14.7 million adult smokers have switched to IQOS and stopped smoking, with the balance in various stages of conversion. Strong conversion rates notably reflect the increased prevalence of IQOS 3 DUO, which offers a superior user experience to previous device sessions. We seek to achieve even higher conversion rates over time with the introduction of innovations such as IQOS ILUMA. This user growth, again, reflects widespread momentum across all key IQOS geographies, including the EU region, Japan, and Russia. It also reflects the enrichment of our offer and the segmentation of the category with new products and more price points, both above and below our initial HTU offering. In the EU region, second quarter share for EHTS reached 5.5% of total cigarette and HTU industry volume, plus 1.6 points higher than Q2 last year. As mentioned, last quarter we expected sequential share for HTUs to be broadly in line with the first quarter due to the effects of seasonality and pandemic-related fluctuations on the combustible market. Underlying trends remained strong, with Q2 HTU IMS volume growing plus 50% year-over-year, and around plus 11% sequentially when adjusted for estimated trade inventory movements. We expect to see similar dynamics in the third quarter, with broadly stable headline share versus robust underlying growth. This excellent performance includes strong growth across the region, with Italy and Poland as notable contributors. We continued to grow our EU region IQOS user base, doubling since the start of 2020 despite the pandemic, to reach over 6.3 million. Strong performance continued in Russia with 8% sequential user growth in Q2, and our HTU share increased by 1.3 points to reach 7.3%. As in the EU, sequential share can be distorted by the combustible market. Adjusted for estimated trade inventory movement, this reflects close to plus 30% year-over-year IMS growth. After the excellent progress and geographic expansion of IQOS in recent years, the heated tobacco category in Russia is now large and growing. This very positive dynamic naturally attracts competition, and as seen before in markets like Japan, heavily discounted competitive offerings can generate initial consumer trial. We continue to grow our user base, and with both our existing price tier portfolio and the future launch of IQOS ILUMA, we see ample room for further strong growth. While we have historically focused on Russia in our earnings calls, there is negative noise around HTU growth across the Eastern Europe region with Ukraine, Kazakhstan, and Southeast Europe significantly contributing. We show here the excellent overall original growth trend in adjusted IMS. Note that following recent international sanctions, IQOS is no longer available for sale in Belarus, where we achieved a Q2 uptake share in means of almost 7%. We continue to see sequential volume growth for both our HEETS and Fiit lineup in Russia and Ukraine. Moreover, this solid and fit consumable continued to supplement user acquisition. In both Russia and Ukraine, the majority of consumers purchasing a LIL device are smokers entering the smoke-free category for the first time, with a high level of conversions in line with IQOS, benefiting from our IQOS conversion infrastructure. With this success, we also introduced LIL SOLID in 5 further markets in Eastern Europe this quarter, with additional markets planned later this year. Japan, the adjusted total tobacco share for our HTU brands increased by plus 2.3 points compared to the prior year quarter, and by 0.2 points sequentially to 21%, highlighting the strength of our pricier portfolio and broad range of offerings following the October 2020 price increase. IMS volume adjusted for estimated trade inventory movements grew by around plus 5% sequentially, after accounting for fewer selling days in the first quarter. We continue to expect robust underlying progress in user growth and consumer uptake supported by the launch of IQOS ILUMA in August. As in prior years, with an additional excise increase in October 2021, there may be volatility on the timing of IMS and consumer uptake between the third and fourth quarters. In H1, the overall heated tobacco category made up around 29% of the adjusted total Japanese tobacco market, with IQOS maintaining a high share of segment and capturing the large majority of the categories' growth. In addition to strong growth in existing markets, the geographic expansion of our smoke-free products continues. This allows us to provide access to better alternatives to an ever-increasing number of adult smokers, as we aim to be in more markets by 2025. Our second quarter launches in Kyrgyzstan and Uzbekistan with both IQOS and LIL offerings, take the total number of markets where PMI smoke-free products are available for sale to 67, of which over half are outside the OECD. Core drivers of our continued success in smoke-free products is innovation. We are very excited to launch IQOS ILUMA, the next generation of IQOS, next month in Japan. Building on the success of IQOS 3 DUO, we believe this simple and intuitive device will support easier switching and higher conversions for legal age smokers using Smartcore internal induction heating technology. As outlined at Investor Day, ILUMA will come in multiple device formats, and have its own range of HTU consumables. The ongoing success of IQOS, nearly 2 years after launch, demonstrates that significant innovation can have a lasting positive impact on growth. We plan for further market launches of IQOS ILUMA through the remainder of this year and in 2022. Naturally, for a major new innovation, as seen with earlier versions of IQOS, the unit cost profile of IQOS ILUMA devices and consumables begins at a higher level, but we expect this to improve over time as scale increases. This dynamic is included in our guidance assumptions. We are continuing to commercialize IQOS VEEV with good progress in the first group of markets, where we started in our own channel with an initially limited range of test variants and nicotine levels. IQOS VEEV is a premium product providing a superior experience. As we explained previously, the commercial infrastructure of IQOS allows us to deploy efficiently and at scale through a bespoke route-to-market approach. As we start to expand distribution and the consumable offering, we see signs of increased uptake and clear positive consumer feedback relative to competitive products. We plan to launch in further markets later this year, and we'll continue to test edge verification technology in select markets. In addition to heated tobacco and e-vapor, we announced in February our intention to enter the small but fast-growing nicotine pouch category this year. To complement our internal development, we have two important acquisitions to establish a base of capability in science, technology, and manufacturing, and build our platform in Modern Oral. The first of these was AG Snus, completed during the second quarter. AG Snus has a relatively small branded portfolio of Modern Oral products, which provide us a foothold in the category. In addition, the proposed acquisition of Fertin Pharma will give us access to a range of promising oral delivery technology and capability, some of which could be applied to the Modern Oral Nicotine space. We will return with further news on our commercial plans in this area later this year. I also want to come back to our Beyond Nicotine strategy, which we first outlined at Investor Day. We see significant opportunities in adjacent areas with our two focus corridors of self-care wellness, including botanical, and inner therapeutic, expected to have an addressable market of around $65 billion by 2025. The proposed acquisitions of Fertin Pharma and Vectura can enable us to more rapidly expand our development capabilities in innovative health and oral product formulations while continuing to grow their respective CDMO activities. Fertin has a range of promising oral delivery technologies, including pouches, gum, and lozenges, which can be applied in both the Modern Oral Nicotine and Beyond Nicotine areas, notably for self-care wellness products. With Vectura, we would gain access to differentiated proprietary technology and pharmaceutical development expertise to deliver a broad range of complex inhaled therapies. Vectura has highly complementary human capital, technology, high-quality infrastructure, and deep know-how of inhalable formulation and device design development and analysis, drug device combination, and pharmaceutical management processes and systems. These proposed acquisitions would fully leverage PMI's existing capabilities in life sciences, product innovation, and clinical expertise related to inhalation. Such acquisitions can also enhance our progress on important sustainability priorities. Firstly, building our capabilities in Modern Oral is a key enabler of broadening the reach and access of our smoke-free alternatives to other smokers around the world. Secondly, building a strong Beyond Nicotine business is a major objective as we strive to develop commercially successful products with a net positive impact on society. On ESG and sustainability more broadly, we are firm believers in the power of investor engagement to drive positive change. Given PMI's unique sustainability and transformation story, we have increased our own outreach. We published our second integrated report in May, which provides comprehensive detail and transparent disclosure of how we create sustainable value and how we are progressing toward our purpose and targets, including our most important commitment of all: to phase out cigarettes. We also had a dedicated sustainability webcast on June the 2nd, where we covered the fundamental alignment of our transformation and financial performance with addressing our impact on society. We shared the latest studies using real-world data on a possible association between accelerated cigarette volume decline and certain disease reduction in Japan. We also reaffirm our commitment to diversity, equity, and inclusion as an essential enabler of future success. We continue to make progress on our 2025 roadmap with notable developments in Q2 being our second certified carbon-neutral factory in Switzerland, taking us one step closer to achieving carbon neutrality by 2025, and the publication of our eco-design principles, as we seek to play our part in the circular economy. In closing, after delivering 1% total volume growth and 7% organic revenue growth in H1, we have raised our 2021 organic growth expectations to plus 6% to plus 7% in net revenue, and plus 12% to plus 14% in adjusted diluted EPS. We are on track for an excellent performance. Moreover, we continue to invest in the future. Most immediately, this means the launch of IQOS ILUMA in Japan next month and in more markets later this year. We are also investing in the broadening of our smoke-free product portfolio and geographic reach. This is critical as we seek to accelerate the number of adult smokers who switch to better alternatives, with the growing positive impact on society. In addition, we are investing in the capabilities of tomorrow as illustrated by our two recent proposed acquisitions, which provide a comprehensive development platform across our Beyond Nicotine focused areas. Finally, we are also committed to returning cash to shareholders through dividends and share repurchases in line with our strategy to deliver sustainable value and returns to investors as we continue our journey towards becoming a majority smoke-free business. Thank you very much. I am more than happy to answer your questions.

Operator, Operator

Thank you. We will now conduct the question-and-answer portion of the conference. In the interest of fairness and time, we ask that participants keep it to a maximum of two questions each. Our first question comes from the line of Chris Growe with Stifel. Please go ahead.

Chris Growe, Analyst

Hi. Good morning.

Emmanuel Babeau, Chief Financial Officer

Hi, Chris.

Chris Growe, Analyst

Hi, and nice quarter there. I do want to ask you two questions if I could, please. I want to start first with, you have IQOS ILUMA launching soon in Japan, and I assume you'll go into more markets. I think in this quarter you had shipments above consumption. Would you expect that still to be the case? I know you've mentioned building inventories. Would that still likely happen in the second half of the year or have we already built inventories sufficiently to handle that launch?

Emmanuel Babeau, Chief Financial Officer

Thank you, Chris. No, I think there was an element of preparation for the launch in this Q2. For the rest of the year, at that stage, we expect IMS and shipment to be more aligned, so we don't expect to have further material differences at that stage emerging in H2.

Chris Growe, Analyst

Okay. And just a question on the combustible business, and I know you gave some good detail on that. I guess my question would be that you did have a softer market share overall in combustibles. I think you mentioned you expect your share to stabilize there over time. I just want to get a sense if you thought that you could stabilize your combustible market share this year? And I think related to that, just to maybe give a little more color around the pricing environment and how competitive it is right now in combustibles, I think there may be a factor that's contributed to less pricing for your business in that area.

Emmanuel Babeau, Chief Financial Officer

Sure, Chris. On this objective to stabilize our market share in the combustible category, that's a clear objective that we have. Of course, it's a year-on-year stabilization that we want to reach. We are stabilizing sequentially quarter-on-quarter, and it's good to see that the Q2 market share is showing this kind of improvement versus Q1. We are not there yet in terms of stabilization year-on-year. That's an objective that we have gradually for the coming quarters. We'll see when we are able to reach it, but that's clearly something that we want to pursue. On the pricing environment, as you have seen we started nicely the year. Q2 was still quite good. I would cite in Indonesia, we are reporting a price impact of about 5%, so clearly positive. H2 is more difficult as we've been flagging it in terms of basis of comparison. There was a VAT decrease in Germany. There is a different pattern in excise duty increase in Australia, so that is going to play. And we are also going to monitor what is the situation as hopefully we are exiting the COVID crisis, which exact timing and how the exit, but we know that many economies would still stay quite impacted by that. So, we’ll be of course monitoring the capacity of our customers to follow price increases and that will be certainly driving our decision when it comes to price increases. So, I would say we're going to monitor the situation. We're going to see what is happening. There would be certainly a question on evolution of inflation here and there as well that we're going to take into account. So, a lot of unknowns at this stage, but we'll take that into account to monitor and decide on price increases. Nevertheless, we have been flagging the fact that after a 3% increase in H1, we do confirm the overall bracket of 2% to 3% for the full year, which means that we expect notably and partially because of tougher comparisons in H2, an H2 that could be less favorable in terms of price increases than H1.

Chris Growe, Analyst

Thank you for all the perspectives.

Emmanuel Babeau, Chief Financial Officer

Thank you.

Operator, Operator

Our next question comes from Michael Lavery from Piper Sandler. Please go ahead.

Michael Lavery, Analyst

Thank you. Good morning.

Emmanuel Babeau, Chief Financial Officer

Hi, Michael.

Michael Lavery, Analyst

I just wanted to ask a couple of questions on Indonesia. One, it follows on some of the pricing discussions, I guess. You called it out, obviously, as an offset to some of the favorable pricing. Can you just help us understand a little bit better the dynamics there and what to expect looking ahead?

Emmanuel Babeau, Chief Financial Officer

Sure. So remember Indonesia was a very tough market last year, really hit hard by the pandemic. It doesn't mean, unfortunately, that the country has exited the crisis. Until recently, there have been new announcements of lockdowns and restrictions. It's probably the impact was so strong last year that we're comparing to probably favorable basis of comparison, but the situation is certainly not back to normal there. Nevertheless, what we are seeing is certainly an improvement of the situation, again, based on probably favorable comparison. We are doing well ourselves when it comes to the premium market, what we call the Tier 1 with more excise duty, and we are gaining share there, and that explains that we are able to grow our volume this year. But we are also, unfortunately, at the same time seeing the Tier 2 category, the one enjoying lower taxes, that is still gaining ground and probably getting close to 30% market share. It used to be, at the end of last year, around 25% to 26%. So, that is playing the other way around, and hopefully, this is going to be corrected with evolution in the excise duty policy put in place by the government. But, of course, we don't have any news on that and we don't know if and when it's going to happen. That is the situation that we are facing. And in Indonesia, there is clearly improvement versus last year. It doesn't mean that the environment, when it comes to possibility of price increases, is becoming favorable, but at least it's no longer the kind of very negatively oriented market that it used to be for us last year.

Michael Lavery, Analyst

And just to confirm then on your pricing, are you saying that you're not getting any increases or have you actually lowered prices?

Emmanuel Babeau, Chief Financial Officer

We are impacted by the increase in duty, so we are increasing prices, but it's still having a negative impact, and that's why there is a difference between what we are reporting in terms of price impact with Indonesia and without Indonesia. So, overall it's still having a bit of a negative impact.

Michael Lavery, Analyst

I got it. So, your increases aren't fully offsetting the duty increase?

Emmanuel Babeau, Chief Financial Officer

That's correct.

Michael Lavery, Analyst

And then just on IQOS in Indonesia, I know you haven't called out a launch there, and the Internet can be a funny creature. But we find about a dozen stores in Jakarta that all look quite proper and have really official sounding language. Are those resellers of products they are getting somewhere else or do you have a sort of a quiet launch there? Can you just give us a status of how IQOS sits in Indonesia today?

Emmanuel Babeau, Chief Financial Officer

So, there is no official launch of an IQOS club where we may gather some users. As you know, Indonesia is first and foremost a kretek market. And while we certainly have the objective to develop a specific heat-not-burn device for kretek, we haven't launched it yet. So, we do that, of course, addressing only part of the population, the one with the purchasing power that can afford the current devices, and also a small group of people that are non-kretek smokers, but that's a very small fraction of the consumer. So, that could be the element that you are referring to, but there is no official global launch at this stage.

Michael Lavery, Analyst

Okay. Thanks very much.

Emmanuel Babeau, Chief Financial Officer

Thank you.

Operator, Operator

Our next question comes from Gaurav Jain from Barclays. Please go ahead.

Gaurav Jain, Analyst

Hi. Good morning.

Emmanuel Babeau, Chief Financial Officer

Hi, Gaurav.

Gaurav Jain, Analyst

Hi. A couple of questions from me. One is on the guidance that you had at Investor Day, you know greater than 9% EPS growth over 2021 to 2023, and you are clearly coming quite ahead of that this year at almost 13%. So how should we interpret it is what I'm trying to understand that there is a slowdown in the next 2 years because you have these tax gap closures in Germany which will impact the high cost realization in that market next year and potentially in some other European markets or could be that the growth is independent ?

Emmanuel Babeau, Chief Financial Officer

Well, thank you for the question, Gaurav. I think you're going too far. We've been sharing this three-year guidance and objective at the time of the Investor Day, more than 9%. We are off to a strong start because we are targeting indeed for the first year 12% to 14%, it's clearly above the 9%, so I think we're compliant for the time being with the overall beyond 9%, and that means that we are certainly on good track to deliver the more than 9%, but I don't see a contradiction between the more than 9% and what you said the new good news, which is the strong start in 2021.

Gaurav Jain, Analyst

Sure. And there is more of these tax gap closures in Europe, how would that impact your potential to achieve this EPS growth guidance?

Emmanuel Babeau, Chief Financial Officer

I mean, of course, you can make whatever scenario, and it's difficult to react to the most extreme scenario. But I think we are taking into account and we have always said that there could be some reduction, gradual reduction to the gap between combustibles, and even on other products when it comes to excise duties. That is absolutely factored in our guidance. We have the capacity to increase price. We've been repeating the fact that IQOS and the consumables that are coming with IQOS is a premium product, that is already a superior experience for the customer. And that is commanding a premium in terms of price positioning as well. Today, thanks to the lower excise duty, very often you're going to have consumables at a cheaper price than the premium combustible product like Marlboro. That is something that, of course, could be changed and we could increase prices. And at the same time, we continue to see more and more governments and regulators saying that there should be a difference between combustible and heat-not-burn because heat-not-burns are better products, and that should be used, certainly, as an incentive to a smoker switching to heat-not-burn category and to move to better products for them. We certainly believe that there will be some decrease in some countries, but it's not going to be necessarily the case everywhere. We could also envisage an increase in the gap. We haven't seen that recently in the EU, but we've been seeing that being installed in other countries. And on the long term, we continue to believe that there will be still some nice differences between the two that are fully justified by the fact that these are better products. And to say that we are ready to cover for certainly possible reduction in the gap. We think that some of that is going to happen anyway for sure, Germany being one example. And at the same time, we believe that there will be growing, I would say, consensus on the fact that there should be a clear differentiation between combustible and heat-not-burn products.

Gaurav Jain, Analyst

Sure. Thank you. If I can ask a quick one on Japan. We have this tax gap closure in October, and that will throw up a lot of volumes up in the market which will be moving, and you're launching IQOS ILUMA. There is a potential to launch a lower-priced IQOS variant, maybe reposition IQOS 3 DUO at a lower price point to capture these volumes from the cigarette low category which will probably move.

Emmanuel Babeau, Chief Financial Officer

Certainly, Gaurav, with IQOS ILUMA, we are going to enrich the premium category for our products. And as we keep saying, that's going to be a real, I would say, major change for customers, and it's going to represent for them clearly a big, big progress, eliminating the remaining pain points. And therefore, of course we focus on that for the time being. We believe the potential is huge as we've been highlighting. Now, depending on how the market is evolving, certainly we'll see what is the interest of launching new devices with a different positioning. The ultimate goal, as we also said in several instances, is certainly, in any case, to have a full coverage of the spectrum of the market, from the most premium positioning to certainly more value-for-money designed to cost simple products that are of course delivering an experience that is not at the level of the prime experience, but that is value for money and good enough experience for other types of customers. So Japan will make no exception in our willingness to cover once again, the full market from premium to medium and even low-price positioning.

Gaurav Jain, Analyst

Thanks a lot.

Emmanuel Babeau, Chief Financial Officer

Thank you.

Operator, Operator

Our next question comes from Bonnie Herzog, from Goldman Sachs. Please go ahead.

Bonnie Herzog, Analyst

Thank you. Hi, Emmanuel.

Emmanuel Babeau, Chief Financial Officer

Hi, Bonnie.

Bonnie Herzog, Analyst

I wanted to follow up on guidance and have a couple of questions. Regarding your EPS guidance for the full year, while you expect industry volumes to improve, it suggests a notable slowdown in growth in the second half despite having an easier comparison from last year. You mentioned some factors, including additional costs tied to the rollout of ILUMA and potential gross margin pressures as you anticipate selling more devices in the second half. I want to ensure I fully understand all the factors and any additional pressures you expect for the second half. Additionally, I wanted to clarify your stance on buybacks. You indicated that your guidance does not reflect a significant impact from any share buybacks, but I want to confirm whether this means you won’t be buying back shares as aggressively in the second half or if you’re not considering buybacks at all in your guidance. Could you clarify that for me?

Emmanuel Babeau, Chief Financial Officer

Sure, Bonnie. Very clear. Maybe starting with the buyback to make it clear. No, no, we're not making any kind of guidance on what's going to be the buyback or assumption. As we said, we want to be really, super flexible. And frankly, all scenarios for the magnitude of the buyback in H2 can be envisaged. But precisely because we want to keep flexibility, we don't want to put any kind of assumption on the amount of buyback for H2. That's really the way you should understand it. Now on the H2 margin versus H1, because I guess that's really your question. I think you started to summarize well the reason for the different margin evolution profile, but I'm happy to go through all the elements. Certainly, what's going to be common between H1 and H2 is strong dynamism in top line with continued favorable evolution, of course, on our IQOS business. We are still facing on the combustible business, also, some relatively easy comparison from last year, so that should have an impact on our combustion business. We continue to have the nice mix impact driven by the IQOS growth on our revenue first week, so that is going to stay. And of course, that's the reason why we are raising the guidance on the revenue organic growth to 6 to 7. It's our confidence on the continuation of strong dynamism on revenue growth in H2. Then on other elements that could be different, there is, as I said in answering a previous question on price, we see H2 possibly being more challenging than the 3% price increase on the combustible business that we delivered in H1, so that's clearly one element. Another one is the level of productivity. You have seen the number $300 million. In H1, we target $1 billion over a 3-year period. Obviously, the $300 million is not necessarily a sustainable amount if you want for a 6-month period. So there was some front-loaded element in productivity this year. It doesn't mean that we don't intend to generate a nice productivity in H2, but not necessarily at the same level as the $300 million in H1. That's going to be another element. Then there are all the impacts of the launch of ILUMA. And I see indeed on the margin to impact one is the fact that when you launch a new product, it's true for any business or any industry. Your costs are not optimized. You don't have yet the volume to fully amortize all the investments. You haven't been optimizing all your processes. So there will be an impact on the gross margin coming from increased costs as we launch ILUMA. This is going to, of course, disappear over time. I'm not able to tell you exactly how long it's going to take, but let's say 18 to 24 months is the typical horizon to get to full productivity when you have some innovation. This is going to have an impact on H2. Then, we said it as well, the fact that we're going to sell more device, an ILUMA device, that is going to boost revenue, but it's not going to have the same impact as consumables on the gross margin, and, of course, with an impact on the gross margin rate. And the last element that I have certainly top of mind, these $300 million to $400 million increase investments in H2 versus H1. And these investments are going to be obviously where it's going to make an impact for the Company. So it's about innovation, it's about commercial and marketing capacity, it's about digitizing further our business and the Company. That's where we're going to put that money. So you need to take all these elements into account to understand the different profile of margin evolution between H1 and H2. But having said that, obviously, we are still targeting a very nice growth of our revenue OI and adjusted EPS in H2.

Bonnie Herzog, Analyst

Okay, that was really helpful and I appreciate all that. Obviously, there's a lot of puts and takes, but broadly, given the raised guidance, you feel pretty darn good about the momentum and just the improvements in industry volumes. That's encouraging. If I may, I wanted to ask a second question just on the competitive environment, especially as I think about what Japan Tobacco is doing by launching their new Ploom X. And it sounds like they plan to launch it at a pretty steep discount to drive trial. Now, this coincides with the launch of ILUMA in Japan. I just wanted to understand your strategy in terms of positioning ILUMA especially as it relates to price. Maybe overall, how concerned are you with stepped-up competition and how confident are you that you're going to be able to maintain share and ultimately continue to take share? Thanks.

Emmanuel Babeau, Chief Financial Officer

Yes. Bonnie, certainly, that's of course a very good question. I'm happy to elaborate on it. First and foremost, and that's probably the most important in my answer, we are really happy to see competition really taking now the heated tobacco category as a big priority. And showing, I think, increased commitment and engagement beyond the category. We think that the shared vision on the fact that we need jointly to phase out cigarettes and develop better products for smokers is a way, certainly, to accelerate the journey to end smoking in the world. To see competition realizing that this is a great category, this is answering smokers' needs and expectations, putting more innovation, more investment in the category, that's just great. And I think we can start seeing in some geography where competition increases investment, we can see the overall growth of the market accelerating. And of course, as we take a lion's share of that, that is very good news. Having said that, obviously, what is important for the smoker is the capacity to find with heated tobacco technology and proposals something that is mimicking, to the closest way possible, the experience versus combustible cigarettes. And that's where our technology, our capacity to innovate, is making a big difference. And that's where probably some of the competition is struggling a little bit, and that is the reason why some of them believe that they have to discount their product to get some traction. So what does it generate? At the end of the day, it generates the fact that you may have a trial because the device is coming almost for free, and the consumable is cheaper. But then if it's not satisfactory, if it doesn't provide the same pleasure, the same benefit as what you have with an IQOS experience, and we love further more with IQOS ILUMA, then whether you switch back to IQOS, or you may just be back to combustible cigarettes because you're feeling that that's not satisfactory versus what you really enjoy. And therefore, it's not whether playing the role of converting smokers to heated tobacco and you create lower average consumption devices and lower loyalty. So we continue to be a firm believer that, at the end of the day, just the right technology, the right experience will convert the majority of the smokers to switch to better products and to the heat-not-burn category. And we believe that this is exactly what we are offering with IQOS. And that makes us confident in our capacity to retain big market share. It doesn't mean that we're not going to propose also, simpler devices, always with our capacity to innovate, targeting, as I said, different purchasing power, different expectations. But certainly we will continue to lead the way when it comes to premium products delivering a superior experience.

Bonnie Herzog, Analyst

Alright, very helpful again, thank you so much for all of that.

Emmanuel Babeau, Chief Financial Officer

Thank you, Bonnie. Thank you.

Operator, Operator

Our last question comes from Pamela Kaufman, from Morgan Stanley.

Pamela Kaufman, Analyst

Hi. Good morning.

Emmanuel Babeau, Chief Financial Officer

Hi, Pamela.

Pamela Kaufman, Analyst

I was hoping that you could elaborate on your plans for increased investment in the second half in terms of what initiatives you will be spending behind, how much will be for ILUMA versus VEEV or the other reduced risk offerings. And then in terms of the level of spending, the $300 million to $400 million, is that primarily related to the launch in Japan? And should we think about annualizing this level of incremental investment for next year as you expand into additional markets?

Emmanuel Babeau, Chief Financial Officer

Thank you, Pamela. I have to say, I fully understand your curiosity and that you want to know more about this extract in order to form an opinion. But I'm afraid I will have to disappoint you because, as you can imagine, that is super sensitive and we don't want to disclose the details of that. Nevertheless, I'm certainly happy to say that we are putting investment in places that are going to move top-line, i.e., growing more volume, more conversion on a smoker switching to IQOS. Certainly, part of the amount is going to be behind the launch of IQOS ILUMA. But not only, there are also commercial activities. As we see, a number of markets returning to a certain normalcy. I will not say we are fully there, but certainly more reason to reaccelerate a number of marketing and commercial activities. And that's going to be important. We are also accelerating in terms of innovation, and we are putting more money in life science and to build more presence in the RRP category notably, so that's part of the acceleration. And we also signal it’s going to be much more marginal, but that we may have to very selectively reinvest here and there in combustibles where it's possible. I would say it's going to be a small fraction of the extra investment, but we have this objective of stabilizing our market share. So I think with that, Pamela, you have really what is behind the $300 million to $400 million. No, you don't need to necessarily annualize that, but let's be clear we're going to launch ILUMA in many more countries next year in 2022. And I'm not able to elaborate at that stage on what's going to be the plan in terms of investment, but I would expect that, yes, we'd certainly want to invest with a great return on this new offering and new technology. So that would have some impact on our investment next year. Remember, nevertheless, we have a very ambitious program to generate $1 billion efficiency on SG&A. We have ambitions to be very dynamic on revenue. And therefore, our goal over a three-year period is to reduce nicely the SG&A on revenue ratio to create a driver for increased profitability. And of course, including all this investment that absolutely remained a big ambition that we have.

Pamela Kaufman, Analyst

Thank you. That's very helpful. And my other question is, can you discuss the rationale behind the new management structure in the Americas? I'm just curious how, if at all, it influences the Company's priorities in the region. Should we anticipate any changes to the way that IQOS U.S. rollout is conducted, or any changes in the Company's strategy towards the U.S. market, particularly given that Deepak Mishra's background is in strategy and M&A?

Emmanuel Babeau, Chief Financial Officer

Well, thank you for highlighting the great talent of Deepak and we're all very pleased to see him taking his new responsibility. I think it just highlights, certainly, the potential that we see globally for the Americas but notably, of course, for the U.S. We want to keep working in close interaction with Altria on IQOS. We flagged the fact that we could have, certainly, for IQOS VEEV some ambition. You will allow me not to elaborate more on that, but that certainly means that we see the U.S. as actually a country where reduced risk products have great potential and we want to participate in that potential.

Pamela Kaufman, Analyst

Thank you.

Emmanuel Babeau, Chief Financial Officer

You're welcome.

Operator, Operator

Our last question comes from Vivien Azer from Cowen. Please go ahead.

Vivien Azer, Analyst

Hi. Good morning. Thank you.

Emmanuel Babeau, Chief Financial Officer

Hi Vivien.

Vivien Azer, Analyst

My first question is on VEEV. I was wondering if you could expand and offer any preliminary insights. I know that it's still early days, but for the consumers that are engaging with that product, are they skewing towards legacy IQOS consumers, are they newer IQOS consumers, or new consumers to the platform in general? Any other insights would be very helpful. Thank you.

Emmanuel Babeau, Chief Financial Officer

Sure, Vivien. Indeed, we are on VEEV, this is what I could call a soft launch for a number of reasons. We want to learn the category. We are learning in many dimensions including age verification, which we see as absolutely paramount. And the obvious initial move from us was to put VEEV as the nice complement for some of the already IQOS users in the case of polyusage. And that was a natural move from people who were knowledgeable of IQOS already, the technology, the great experience the IQOS brand can provide. I think we are moving now to new dimensions. We have beyond this initial move some great feedback coming from consumers that show that it's not only the elegance of the design, but the overall experience, the quality of the product that is comparing very well when we do tests versus competitors. So time to certainly accelerate in our ambition that will come with more launches, of course, development of more flavors. So after this first step in the category, you should expect us to certainly increase ambition on vaping.

Vivien Azer, Analyst

Perfect. Thank you. And my follow-up question is just on capital allocation. It's been a while since we've seen the Company be this acquisitive. In short order, do you feel comfortable that you've filled white space or knowledge gaps in your portfolio, or should we expect more bolt-on acquisitions going forward? Thank you.

Emmanuel Babeau, Chief Financial Officer

My view would be, Vivien, that with the proposed acquisition of Fertin and Vectura, we would certainly really build a very strong platform on which for our two ambitions on inhaled therapeutics and on self-care wellness, we would have indeed very strong platform, and notably from a life science perspective. For the life science, that would be great. That's certainly the view that we have today on that topic.

Vivien Azer, Analyst

Thank you.

Emmanuel Babeau, Chief Financial Officer

Thank you.

Operator, Operator

This concludes the question-and-answer session. I will turn it back over to management for closing remarks.

Emmanuel Babeau, Chief Financial Officer

Alright. Well, let me leave you with some key messages then. First, despite the slower recovery from the pandemic in certain markets, we are happy to report a very robust first half performance with a record high adjusted diluted EPS and raised 2021 guidance. Second, the impressive growth of IQOS continues. And we remain on track to deliver our target of 95 to 100 billion units for the year. Third, our Combustible Business is improving sequentially as the recovery from the pandemic infraction in many key markets. Lastly, we are building towards important milestones in our Beyond Nicotine strategic vision, as part of our business transformation. Thank you again for joining us and talk to you soon.

Operator, Operator

This concludes today's conference call. You may now disconnect.