Emmanuel Babeau
Chief Financial Officer at Philip Morris International
Thank you, James. Welcome to you in your new role, and welcome, everyone. Before I begin, I want to reiterate our focus on supporting our employees and their families affected by the war in Ukraine and above all on the safety of our people. We continue to deploy pledge humanitarian support and additional benefits for our Ukraine employees. As previously announced, we intend to exit the Russian market in an orderly manner, as the complexities of continuing to operate in Russia increase such as supply chain challenges and financial and banking sector restriction.
We continue to actively work on options for doing so in the context of an increasingly complex and rapidly changing regulatory and operating environment, including the requirement to obtain certain governmental approval for any transaction. Turning to our business. We demonstrated strong underlying momentum in the second quarter of 2022 with another quarter of positive volume supporting better-than-expected top and bottom line growth. Most impressive was the continued excellent IQOS performance and strong Q2 pro forma user growth of more than 1.1 million, demonstrating further sequential acceleration compared to Q1 as device limitation and COVID restrictions continue to ease.
This reflects strong momentum in the EU region, Japan and developing market. Q2 RP pro forma net revenues grew by plus 11% despite the adverse shipment timing impact due to supply chain constraints highlighted last quarter, while HTU IMS volumes grew by plus 20%. IQOS ILUMA delivered further impressive results in its first three markets of Japan, Switzerland and Spain. The acceleration in category growth in these diverse geographies highlight the exciting future growth opportunity across the world, including in the latest launch market of Greece.
In combustible, robust Q2 pro forma volume growth of plus 2.4% and organic net revenue growth of plus 4.2% were driven by Marlboro share gains, stronger pricing and the continued recovery of the markets. Maintaining leadership of the cigarette category allows us to maximize the switching of adult smokers to smoke-free alternatives and accelerate our transformation into a predominantly smoke-free business by 2025. We expect the strong underlying momentum of our business in H1 to continue, and we are from an organic growth outlook for the year. We are now well on track to deliver two consecutive years of volume growth, confirming our status as a growth company in terms of volumes, organic net revenues and margins.
Despite a substantial currency headwind in 2022, we expect to deliver full year adjusted diluted EPS of around $6, including Russia and Ukraine. The proposed addition of Swedish Match would further boost our future financial profile. This is a value-creating offer for both set of shareholders with a compelling strategic and cultural fit, providing an additional opportunity to accelerate our smoke-free future. Turning to the headline numbers. Our Q2 volumes grew by plus 3% on a pro forma basis and by plus 1.1% in total, including Russia and Ukraine. Pro forma net revenues grew organically by plus 6.2% and by plus 5.3% for total PMI, reflecting both the continued strong growth of IQOS and the ongoing recovery of the combustible business in many markets against a pandemic affected comparison.
As we anticipated and indicated previously, less unfavorable timing of cigarette shipment also played a role, notably due to replenishment of duty-free inventories. Our total organic net revenue per unit grew by plus 3% on a pro forma basis and by plus 4.1% in total despite the expected delay of HTU shipments to Japan as we manage through global supply chain disruption. This incorporates combustible pricing of plus 3.5% on a pro forma basis or almost plus 5% excluding Indonesia. Our Q2 adjusted operating income margin declined organically by 190 basis points on a pro forma basis and by 150 basis points in total. As expected and communicated in our Q1 quarterly results, this reflects four main factors: first, investment to further expand and match the speed of growth in our smoke-free portfolio.
This includes the initial higher cost of ILUMA devices and HTUs and the transitory dilutive margin impact of higher device sales as we roll out ILUMA and replenish distribution channel as device constraint ease to support reaccelerating IQOS user growth. Second, the impact of supply chain disruption, notably due to the war in Ukraine, including around $80 million in additional air freight expenses. Third, inflation of around 4% in our cost of goods driven by the global pandemic recovery and exacerbated by the war, notably for certain direct materials, wages, energy and transportation costs. And last, a challenging prior year margin comparison, which included substantial cost of goods sold productivity savings.
Despite these typical margin challenges, our robust top line growth and ongoing cost efficiency enable us to deliver plus 5.6% growth in pro forma currency-neutral adjusted diluted EPS ahead of expectation to $1.32 and plus 3.8% growth for total PMI to $1.48, including Russia and Ukraine. Looking at the first half of the year now, our volumes grew by plus 4% on a pro forma basis and by plus 2.2% for total PMI. Pro forma revenues grew by plus 8.1% and by plus 7.1% in total, also driven by strong IQOS performance and the recovery of the cigarette category. We delivered organic net revenue per unit growth of plus 4% on a pro forma basis and plus 4.7% in total, again, reflecting the positive impact of growing HT volumes and pricing.
Our H1 adjusted operating income margin contracted organically by 110 basis points on a pro forma basis and 90 basis points in total, driven by the factors mentioned previously. We expect better margin performance in H2, a topic I will review it shortly. Currency-neutral adjusted diluted EPS grew by plus 10.4% to $2.79 on a pro forma basis and plus 9.2% in total to $3.06, an excellent performance given the circumstances. Reflecting this strong momentum, we have our guidance for 2022. With strong IQOS growth and robust trends in combustible, we foresee an acceleration in our currency-neutral growth expectation relative to our previous forecast.
First, we now expect to grow our total pro forma shipment volume by plus 1.5% to plus 2.5% for 2022, achieving another year of volume growth. For pro forma net revenue, we expect to deliver between plus 6% and plus 8% organic growth as compared to the plus 4.5% to plus 6.5% announced previously, despite a greater-than-anticipated drag from hyperinflationary accounting in Turkey. With a strong recovery in device volume, the increasing contribution of ILUMA with initially higher unit cost and ongoing global inflation, we are narrowing our forecast for pro forma adjusted organic OI margin expansion to between zero and plus 50 basis points. We are also raising our growth outlook for pro forma currency-neutral adjusted diluted EPS to between plus 10% and plus 12%.
This reflects a range of $5.23 to $5.34, including an estimated unfavorable currency impact of $0.80 at prevailing rates notably due to the euro and Japanese yen. We'll include a slide in the appendix with further detail on this estimated impact. For total PMI, which assumes a full year contribution from Russia and Ukraine, we expect adjusted diluted EPS of $5.90 to $6.05, reflecting similar dynamic to the pro forma basis and including an estimated $0.69 unfavorable currency impact. Please note our 2022 forecast assumes no contribution from the proposed combination with Swedish Match which is expected to close in the fourth quarter of this year, subject to Swedish Match shareholder acceptance and the necessary regulatory approvals.
The outlook for IQOS growth is excellent, and we now expect to deliver full year pro forma HTU shipment volume of 90 billion to 92 billion units, representing the upper half of our previous forecast range. With growth momentum very strong, the main constraint for not further raising our HTU volume target is our production capacity, notably for ILUMA HTUs due to their outstanding initial success and the cancellation of production in Russia as we convert existing production line for induction consumable. We continue to expect excellent HTU growth in the coming quarters with a progressive improvement in ILUMA HTU capacity through the first half of 2023.
We are prioritizing ILUMA launch markets accordingly with further launches plan in Q4 as communicated previously. A notable further update to our outlook is an increase in our operating cash flow forecast to around $10.5 billion as compared to around $10 billion previously despite notable currency headwinds. This includes our accelerated pro forma earnings growth forecast and an assumed full year contribution from Russia and Ukraine. We delivered robust operating cash flow growth in H1 of plus 14%. And as shown through the challenges of recent years, the cash generation capacity of our business remains exceptional.
While flatted somewhat in 2021 by favorable timing and one-off impact, our revised full year forecast demonstrates underlying growth against this exceptional year after also accounting for higher inflation driven working capital requirements and currency. This underlines our ability to maintain a strong balance sheet, pay down debt and invest in the growth of our business. Our net debt of $23 billion on June 30, 2022, decreased compared to both June and December 2021, despite H1 capital expenditure of $0.5 billion and ongoing dividend payment. Our commitment to our progressive dividend policy is unwavering and we look forward to the additional cash flow, the proposed combination with Swedish Match would bring.
We also continue to expect around $1 billion in full year capital expenditure. Moving now to the pro forma outlook for the second half. We expect to deliver strong top line growth, organic adjusted OI margin expansion and further acceleration in bottom line growth. For Q3, we expect mid-single-digit organic top line growth driven by IQOS with around $22 billion in pro forma HTU shipment volumes. While there is a tougher comparison for cigarette and a modest negative impact expected from shipment timing, we expect combustible volume trends to remain resilient by historical standards.
Net revenue growth will also continue to be impacted in both Q3 and Q4 by the shift to hyperinflationary accounting in Turkey. While the temporary cost headwinds in Q2 are expected to ease somewhat in the third quarter, we expect this to be broadly offset by a step-up in smoke-free commercial and R&D investment as compared to a device constraint in Q3 2021. This results in an expected Q3 pro forma adjusted diluted EPS range of $1.23 to $1.28, including an estimated adverse currency impact of $0.24 at prevailing rates. We expect a strong Q4 with a rebound in HTU shipment volume due to phasing to the most pronounced as HT capacity constraint improve.
The H2 recovery in our pro forma adjusted OI margin is also expected to be Q4 weighted. Turning back to our results. Pro forma HTU in-market sales volume grew strongly by plus 20% for both the second quarter and the first half, notably driven by strong performance in the EU region. As expected, Q2 IMS pro forma growth was significantly ahead of shipment volume growth reflecting the later timing of shipments I mentioned earlier. Our total pro forma shipment volume increased by plus 3% for Q2 and plus 4% for H1. As I touched on earlier, this put us well on track to deliver total volume growth for the second consecutive year on both a pro forma and total PMI basis.
With the impressive performance of IQOS, heated tobacco units comprised 12.6% of our pro forma shipment volume in H1 or 14% in total despite the anticipated HTU shipment timing impact in Q2. Our sales mix is also changing rapidly as we aim to become a majority smoke-free company by 2025. Smoke-free net revenues made up almost 30% of our pro forma total and exceeded 30% for total PMI in the first half of the year. IQOS devices accounted for approximately 5% of the $4.2 billion of pro forma H1 RRP net revenues. This reflects higher device volume at a lower average price than last year as we expand our device portfolio with VEEV and ILUMA ONE and price ladder, our blade device portfolio in preparation for the launch of premium position in ILUMA.
The positive momentum of IQOS continues and is further accelerating in many geographies, providing a powerful driver of revenue and margin growth. We delivered organic growth of plus 8.1% in H1 pro forma net revenues and shipment on growth of plus 4%. This reflects between engine driving our top line in addition to volume. The first is pricing led by combustible. The second is the increasing mix of RRPs in our business at higher net revenue per unit, which continued to deliver substantial growths. This is an increasingly powerful driver as our transformation accelerate. Let's now turn to the drivers of pro forma adjusted OI margin which contracted organically by 110 basis points.
Pro forma gross margin decreased by 280 basis points organically, reflecting the factors I mentioned previously, as we invest in our smoke-free business and manage temporary supply chain disruption and cost inflation. This margin headwind was partially offset by better pro forma adjusted marketing administration and reserve costs, which improved by 160 basis points organically. This was driven by the positive operating leverage of RRP growth and successful cost efficiency program where we generated around $420 million in gross cost savings, of which approximately $170 million came from COGS productivity and over $250 million from SG&A.
With more than $1.2 billion of savings realized by this halfway point, we are well on track to deliver cost savings of $2 billion for 2021, 2023. This allows us to reinvest in top line growth and mitigate inflationary pressures while continuing to deliver margin expansion. We continue to accelerate investment in our commercial programs, digital engine and R&D for long-term growth as well as a number of growth opportunities across categories and geographies. As reflected in our full year outlook, we expect our operating margin trajectory to improve in the second half of the year as temporary headwind and tough comparison in.
Focusing now on combustible, our portfolio again delivered growth in pro forma volume and organic net revenue in Q2. Our pro forma shipment volume grew by plus 2.4% against a pandemic affected comparison notably driven by Indonesia, Poland and Turkey. In addition, we saw a continued recovery in international duty-free outside Asia as passenger traffic increases. Pro forma combustible pricing of plus 3.5% was slightly ahead of our expectations. And while we remain cautious on the economic outlook, the pricing environment has been gradually improving. We expect to deliver a similar level of pricing for the full year. Our leadership in combustibles helps to maximize switching to smoke-free product and both the positive Q2 and H1 segment share demonstrates the strength of our portfolio.
We continue to target a stable category share over time despite the impact of IQOS cannibalization. This year marks the 50th anniversary of Marlboro becoming the world's leading cigarette brand. With the return of social consumption occasion, Marlboro volumes grew plus 7% year-over-year in H1, with category share again surpassing 10% on a pro forma 12-month rolling basis. Of course, our long-standing success in building Marlboro's brand equity is the strength we are now a smoke-free product as we make excellent progress with IQOS as the undisputed global smoke-free leader. The positive combination of a stable share in combustible and the continued growth of IQOS positions to deliver total market share growth over time.
We capture plus 40 basis points of pro forma share gain in Q2 including gains in duty-free, Italy, Japan and Turkey. Moreover, PMI HTU strengthened their position as the second largest nicotine brand in markets where IQOS is present with a 7.5% share, excluding Russia and Ukraine. Moving now to IQOS performance. We estimate there were approximately 19 million IQOS users as of June 30 on a pro forma basis. This reflects very strong growth of over plus 1.1 million users in Q2 and plus 2.2 million in H1, a record first half high on this basis. The acceleration of IQOS user growth compared to both Q1 and last year was driven by the reactivation of acquisition and retention program in many markets as device supply constraint receded as well as the impressive start of IQOS ILUMA.
While device supply constrained has eased in recent quarter, this is largely due to the success of our own proactive effort. The global supply of semiconductors remain tight, and we continue to closely monitor and manage the situation. In the EU region, we are now approaching the milestone of nine million IQOS users, reflecting stepped-up commercial activities to drive acquisition and retention, along with the launch of ILUMA in Switzerland and Spain. Our second quarter HTU share increased by plus 1.6 points to 7.1% of total cigarette and HTU industry volume. As noted in prior years, sequential share compared to Q1 was affected by the usual seasonality of the combustible market with the additional element of a strong year-over-year combustible recovery this quarter.
Most importantly, IMS volume continued to exhibit robust sequential growth, and we expect this to continue in the second half. The strong performance includes excellent user and volume growth across the region with notable contribution from Italy and Poland. Now to give some further color on our progress in the region. This slide shows a selection of the latest key city of Texas in Q2. Despite the denominator effect of the combustible category I just mentioned, share results remain very strong. Most impressive is Vilnius, the first city in the world to surpass 40% share while Athens, Budapest and Rome are in the mid- to high 20s. Elsewhere, we are especially pleased by the results in London, Vienna and Zurich.
In Japan, IQOS ILUMA is driving and our share of market continues to increase in key cities such as Tokyo. Most importantly, our IMS volume trends remain strong with continued sequential growth. As indicated last quarter, Q2 shipments were lower due to timing factors and should recover in the second half with a weighting towards Q4. The adjusted share for our H2 brands increased by plus 1.9 points to a record 22.9% in Q2 despite seasonality. While we are very pleased with these results, our share performance could have accelerated even further. The combustible category was notably resilient in the quarter and our rollout of mainline price entire HTUs for use with ILUMA was slightly slower than initially planned.
However, early results were encouraging. Sensia is designed to cater to its consumers switching to ILUMA and more price-conscious legal-age smokers. We also observed an increase in legal-age users switching from low price competitive heat-not-burn product. We estimate users of competitive offering to have less average daily consumption due to lower full conversion, which we believe ILUMA should improve over time. The heat-not-burn category now represents around 1/3 of total tobacco in Japan with IQOS increasingly driving this year's growth. In addition to strong progress in developed countries, we continue to see very promising IQOS growth in low and medium income market.
The pro forma share of our HTU brands in the 28 such markets launched by December 31, 2021, continued to grow and reach 2.9% in Q2, reflecting sustained growth in IMS volume. Given the large size of this market, the premium positioning of the existing IQOS portfolio and the relatively early stage of commercialization, this represents outstanding progress. A prime example of this are Lebanon where Q2 of take share in Beirut increased by plus 8.1 points to 17.4%, and Egypt where offtake share in Cairo reached around 5% after launching less than one year ago. Other notable successes include the recently launched market of Morocco and Tunisia, as well as Georgia, Jordan, North Macedonia and the Philippine despite pandemic restriction in Manila.
Moving now to IQOS ILUMA, which continued to drive increased conversion and retention rate across initial launch market. In Japan, ILUMA continued to exhibit strong growth with premium priced TEREA HTUs growing rapidly to become the second largest tobacco brand, reaching an offtake share of 14.6% within nine months of national launch. Encouragingly, SENTIA offtake share has already surpassed the level of HEETS in non-perfect covering around 45% of industry volume. The expansion of our device portfolio with ILUMA ONE in Q1 has also seen robust traction with legal-age smokers.
We exited Q2 with a record high of tech share and continue to see a long runway of growth in Japan for ILUMA over the coming quarters. ILUMA and TEREA HTUs also continue their superb start in Spain and Switzerland. We launched ILUMA in Spain in March 2022 with very positive initial results, notably in key cities such as Barcelona and Madrid. Sequential IMS volumes grew by 27% in Q2. TEREA exited the quarter, making up over 50% of HTU sales only four months after commercialization and our national HTU share has grown to plus 1.7%. This is especially encouraging as Spain has been a market where regulatory restriction had limited the speed of IQOS growth. In Switzerland, the demand for ILUMA remains very strong.
IMS volume continued to grow sequentially, increasing plus 13% in the second quarter. A significant proportion of existing users have upgraded to ILUMA and the offtake exit volume of TEREA now exceeds 70% of our HTU sales. We continue to expand our global smoke-fee portfolio through our rich pipeline of innovation. We launched ILUMA in Greece in late June with further market launches planned for Q4. With regard to our new heat-not-burn device tailored to low and middle income market, we continue to plan pilot launches in the fourth quarter, further expanding our portfolio to serve different consumer needs and segment the market.
In e-vapor, IQOS continued to deliver encouraging results, and for example, is now the established number two closed pod brand in Italy with offtake share growing sequentially to around 20%. This is a premium proposition with an average price premium to competitive devices of 20% to 30% as we pursue differentiated and profitable category leadership position over time. In Q2, we expanded into three additional geographies, including France, and are now present in 10 markets. The latest addition to our e-vapor portfolio is the Viva disposable device, responsibly marketed disposable e-vapor product can play an important role as a convenient hassle-free entry into the smoke-free category for legal-age smokers.
Viva was recently launched in Canada with nine varieties. Our geographic expansion of smoke-free products also continued in Q2 with the launch of IQOS in Bahrain. Of course, the biggest potential near-term addition to our smoke-free portfolio is the proposed combination with Swedish Match. This would deliver a major acceleration in our transformation to becoming a smoke-free company. The visions of our two companies are aligned in working towards a smoke-free future without cigarette and would create a global smoke-free champion. If completed, we would have a comprehensive global smoke-free portfolio with leadership position in heat-not-burn and the fastest growing category of oral nicotine with potential for accelerated international expansion.
Another competing rationale for this deal is a large, attractive and growing U.S. smoke-free market. Swedish Match as the leading nicotine pouch franchise within and a substantial U.S. operational platform, which would help us unlock the significant polity across other smoke-free categories over the coming years. This would be a strong strategic and cultural fit, offering significant shareholder value creation over the medium and long term. As stated in the offer document published on June 28, the waiting period for the transaction under the U.S. antitrust process has expired, meaning that we have satisfied our requirement in the U.S. to proceed with the transaction.
We expect the transaction to close in the fourth quarter of this year, subject to Swedish Match shareholders acceptance and the necessary regulatory approvals. Moving to sustainability. I want to first draw your attention to our 2021 integrated report published in May which outlines our new sustainability strategy and ESG performance in detail as we continue to transform for good. Included in the report is our new sustainability index comprised of 19 KPIs across our most material sustainability issues. The index is weighted towards product transformation and now represent 30% of our long-term performance-based equity executive compensation.
The definitions, methodology and scope of each of these KPIs are included in our recently published ESG KPI protocol providing further transparency on how we define success and major ESG performance. With regard to tackling climate change, I am delighted to report that the science-based target initiative as today validated our 2040 net-zero target. The initiative also revalidated our near-term 2030 target for reducing greenhouse gas emission and our new 2025 target for 15% of our suppliers by then to have their own science-based target by 2025 a very positive development, given that Scope three remains the most challenging aspect of any company decarbonization strategy.
To support the achievement of these targets, we are accelerating progress to decarbonize our chain, and we have made eight more factory carbon neutral this year, more than doubling from last year and placing us on track to meet our goal of all factories by 2025. Finally, product health impact remains one of our most critical ESG priorities. There is a growing body of scientific and real-world evidence of the substantial risk reduction potential of smoke-free product compared to smoking. We continue to support policy and fiscal framework that recognize a positive impact tobacco harm reduction policy can have on public health.
Recent examples include a further multiyear tax plan with differentiated treatment for smoke-free products in Romania and statement from the Belgian Super Health Council on the whole e-vapor product can play in switching adult smokers away from cigarettes. To conclude today's presentation, we have delivered a strong first half despite some challenging headwinds, placing us well on track to deliver robust volume growth and an accelerated currency-neutral pro forma financial performance in 2022. We remain excited by the promising results of IQOS ILUMA. Increased consumer satisfaction is driving higher retention and conversion, and we look forward to further market launches later this year.
Our combustible business continues to perform well with pro forma volume and organic net revenue growth, maintaining our share of market over time despite the impact of IQOS cannibalization allows us to accelerate further switching of smokers to better alternative and to invest for long-term growth in the development of innovative wellness and health care product will seek to deliver a net positive impact on society. We continue to enrich our pipeline of smoke-free innovation, such as ILUMA and Viva to expand and grow across new and existing category and geography. We are raising our pro forma growth guidance for the full year and expect to deliver around $6 in total adjusted diluted EPS, including Russia and Ukraine despite currency headwinds.
Importantly, with an excellent 2021 performance and our strong 2022 outlook, we now expect to comfortably exceed our 2021-2023 minimum CAGR target on a pro forma basis of more than plus 5% in organic net revenue growth and more than plus 5% in currency-neutral adjusted diluted EPS growth. Our ambition to become a majority smoke-free business by net revenue in 2025 also remains fully intact. We are confident in the rapid pace of our transformation. Finally, we continue to be steadfastly committed to returning cash to shareholders. Our top priority for capital allocation remain reinvestment in the business and our progressive dividend policy, underpinned by strong cash flow generation.
Thank you, and we are now more than happy to answer your questions.
