Earnings Transcript for IMBBY - Q2 Fiscal Year 2021

Stefan Bomhard: Good morning, everyone. Welcome, and thank you for joining our interim results presentation. I'm joined today by Oliver Tant, our Chief Financial Officer; and Peter Durman, our Investor Relations Director. Lukas Paravicini, our incoming Chief Financial Officer, is also with us. Lukas joined Imperial and the Board on the 1st of May. He will be formally appointed CFO tomorrow and will work with Oliver to ensure a smooth and orderly handover. Now before getting into the results, let me hand over to Lukas for a few brief words.

Lukas Paravicini: Thank you, Stefan, and good morning, everyone. I'm delighted to be able to join the team this morning and to have this opportunity to introduce myself. Perhaps a little bit of my background. I've spent 20 years in the consumer goods industry working in a range of senior finance and operational roles in large international companies. I was at Nestlé for 22 years and worked across a range of parts of the business in Switzerland and in several Latin American markets. I also spent 6 years at Fonterra, the world's largest dairy cooperative and responsible for some well-known leading dairy brands, joining first as the CFO and then becoming Chief Operating Officer of its global consumer and foodservice business. So I bring a blend of strong financial and commercial expertise and have specific experience of driving significant change programs, including implementing global shared services in large international organizations, all of which should be relevant for Imperial. I'm really pleased to be joining the company at such a great time as we begin to implement a new strategy and drive the changes necessary to strengthen performance and to deliver sustainable shareholder value. I'm eager to get to grips with the business and to a time where we can meet in person. I'm looking forward to establishing a transparent engagement with all investors. Thank you. I'll now hand back to Stefan.

Stefan Bomhard: Thank you, Lukas. Today, I will start by providing some performance highlights, and then Oliver will take you through the financial results in more detail. I will then give you more color on how we're implementing the new strategy and some of the operational actions to strengthen performance. I will conclude with our outlook and priorities for 2021. And we'll look forward to taking your questions after that. I'm pleased with the progress we've made on implementing the new strategy we announced in January. The one thing I'm most encouraged by in these results is the progress we've made on stabilizing the aggregate market share performance in our top 5 priority markets following several years of consecutive decline. It reflects an improving momentum from an increased focus on collaboration and performance management with these markets, which are all part of the important changes we've made over the past year. In NGP, the actions we've taken over the past year to focus our investments and improve returns have delivered a further reduction in losses. This is about resetting the business and creating a sound foundation, so we can make a meaningful contribution to harm reduction over time. It has been a good start to the year as we start to build momentum with growth in net revenue, operating profit and strong cash flow. And I would like to thank all of our people for their great work in ensuring the business continues to move forward in a COVID-19 environment. So I'm pleased with the start of the year, and we remain on track to deliver our full year results in line with guidance. As I touched on earlier, our market share in the 5 priority markets increased modestly by 6 basis points compared to a 37 basis points decline in the same period last year. Share gains in the U.S., U.K. and Spain were partially offset by share declines in Germany and Australia, which will take time to turn around. We grew net revenue by 3.5% driven by strong pricing in tobacco and better NGP sales against a relatively weak comparator period. The business has performed well in spite of the coronavirus continuing to influence consumer and customer buying patterns. The lack of international travel has impacted our duty-free sales and also affected demand across markets. Oliver will provide more details later. Our gross and operating profit of 8.1% was driven by a better performance in NGP against the period affected by write-downs and a sharper focus on investment, prioritizing the markets with the best prospects for growth. A stronger performance at Logista also contributed to profit growth. Also tobacco revenue grew, tobacco profitability was affected by some temporary factors that Oliver will take you through in a moment. The good news is underlying tobacco profitability, excluding these factors, grew almost 5%, reflecting our strategic focus on driving the performance from our 5 most important and most profitable markets. We also delivered another strong cash performance on a 12-month basis with net cash flow of GBP 2.5 billion, supporting our debt reduction priorities. Since unveiling, the new strategy in January have been focused on implementation and taking actions to improvement performance. It will take time to get to where we need to be as a business, but I believe we are making the right choices to create value for our shareholders. A key element of the right choices is the clear market prioritization we've now put in place. And we're beginning to realign investments to support the strategic initiatives in our 5 priority markets. In NGP, we've taken steps to reset our approach, and we're managing operations in a much more measured and disciplined manner. I want to see this part of Imperial flourish to enable us to make a meaningful contribution to harm reduction. Our plans for market trials in heated tobacco and vapor are on track. This means investing in markets where we believe we can succeed and withdrawing from markets we don't think we can create shareholder value with our NGP portfolio. Another key priority that has been to assemble the right leadership team with the necessary leadership qualities to deliver the new strategy. The team brings together new capabilities, skills and expertise from outside the industry and blends them with the existing valuable experience we have in tobacco at the senior executive level as well as more widely in the business. I'm pleased that alongside our new strategy, we have been able to attract some very high-caliber individuals with blue-chip FMCG experiences like Nestlé, Unilever or PepsiCo to the tobacco industry. Beyond this, we're also beginning to implement the organizational changes and adopt the new ways of working we highlighted in the strategy update. I will outline later the changes we're already making to our sales and marketing organization to streamline and simplify our operations. Before I hand over to Oliver for his financial review, this is Oliver's last results presentation for Imperial, and I would like to take this opportunity to thank Oliver for his 7.5 years of service to Imperial. On a personal note, I also want to thank him for the very warm welcome he extended to me when I joined the group and for the help and support he gave me with my induction. I wish you all the best for your retirement. Oliver, over to you.

Oliver Tant: Thanks, Stefan, and good morning, everyone. First, let me say I'm pleased to be able to report a stronger set of numbers for my last set of financial results. I'd also like to take the opportunity to thank all of you for the interactions we have had during my tenure and also to say how very much I have enjoyed working with Stefan and the refreshed executive team over the past year. And I wish them and Imperial every success for the future. As Stefan has outlined earlier, our business is performing well with growth in revenue and profit, albeit against a weaker comparator period and with strong continued cash delivery. Total tobacco volumes declined by 3.3%, including a 1.3% reduction from our global duty-free business as restrictions have continued to affect travel. An inventory reduction in the U.S. contributed an 0.8% decline following strong wholesaler purchases in March last year. Excluding these impacts, underlying volumes declined by 1.2%, better than the level we've been used to over recent years. Our volume performance benefited from a 30 basis point share gain across our footprint as well as better market size performances particularly in Northern Europe. Let's take a closer look at how COVID has continued to influence market size. For example, in Spain, the Canaries and in the duty-free channel, we have continued to suffer from the impact of border closures and reduced travel. In contrast, Northern European markets have benefited from higher domestic sales and lower levels of illicit trade. The rate of U.S. market size decline has also slowed from its recent historic trend, where consumer spending has been boosted by stimulus payments. The COVID impact on market size is likely to be less pronounced in the second half as we cycle against comparator already affected by the pandemic. Overall net revenue grew by 3.5% at constant currency. Despite the U.S. wholesaler inventory movements and reduction in duty-free sales, we grew tobacco net revenue by 3.2%. Tobacco price/mix of 6.5% benefited from strong pricing and a return to growth in our U.S. mass market cigar business, which benefited product mix. Geography mix was neutral. Our NGP revenues were up 16% against a weak comparator, which was impacted by destocking of the supply chain. Looking at tobacco price/mix in more detail. We have seen continued strong pricing in both Europe and the U.S. In Europe, positive market mix from sales growth in the higher-margin European markets of the U.K., Germany and the Nordics benefited tobacco price/mix. Our total net revenue performance, however, was held back by the volume reductions in Southern European markets and lower duty-free channel sales, which are reported within Europe. U.S. price/mix was up by 12.7% driven by 2 cigarette price increases in the first half as well as the carryover from last year's pricing. Price/mix further benefited from an exceptionally strong performance from our mass market cigar business. Revenue performance in AAA benefited from improved pricing in Russia and Saudi. However, it was negatively impacted by adverse market mix as volume declines in the high-margin Australian market as well as the prior year stock profit of around GBP 40 million, which benefited revenue and profit in that year. The Australian government has announced there will be no 12.5% duty accelerator this year and thereby limiting the industry's ability to make stock profit this year. This will create a further GBP 50 million headwind to revenue and profit in the second half. We also expect further market size and share declines, which will impact on profitability, although we can absorb these factors within our existing guidance. Adjusted operating profit was up 8.1%. There are 3 factors in the first half of last year that have affected our operating profit performance. These are the U.S. wholesaler inventory pool of GBP 49 million, the timing of Australia's stock profit and the NGP write-downs of GBP 95 million. These net out to a GBP 5 million upside. In this half year, we've made progress in reducing our contingent liability as we reached a settlement for U.S. state litigation in Minnesota. This is a good result. Resolving this issue reduces Imperial's overall risk and the slightly higher ongoing costs are manageable. We expect to do the same shortly in Texas, and we've made a GBP 42 million charge for the settlement, and we retain our guidance for the full year nonetheless. Outside of these items, our underlying tobacco performance was up GBP 76 million or 4.8%. Underlying NGP operating income improved by GBP 46 million driven by our more targeted investment approach and cost cutting. The other key driver of our year-on-year profit performance was distribution, which was supported by better first half trading, particularly in the pharma category as well as recognizing the reduction in inventory levels held by Logista. This follows stock increases last year to reinforce supply contingencies because of COVID-19. The Premium Cigar divestment was a 3% dilution to EPS. Organic EPS performance is up 6.9% at constant currency, benefiting from the higher adjusted operating profit which was partly offset by increased tax rate, as previously guided. We expect the full year adjusted tax rate also to be around 23%. Net cash flow generation remains strong and in line with expectations. However, net cash flow in the first half was impacted by adverse working capital from the unwind of the temporary excise benefit at the end of last year, largely due to Logista. Our 12-month rolling net cash flow increased by GBP 2.4 billion to GBP 2.5 billion. This reflects working capital improvements driven by excise and VAT timings in Logista and the U.K., the rebased dividend and the Premium Cigar divestment proceeds. This net cash flow has been used to accelerate deleverage, supporting progress to the lower end of our target gearing range. As a reminder, we continue to operate a centralized cash pooling arrangement with our entities including Logista. Whilst the daily cash balance will fluctuate, over the last 12 months the average Logista benefit was GBP 2.1 billion. Our 12-month rolling cash conversion of 122% remains high. However, as previously guided, we expect full year cash conversion to be around 80%. This reflects the unwind of Logista excise and duty deferment benefits bestowed by governments in the second half of last year. As highlighted, net cash flow of GBP 2.5 billion has been used to support a reduction in our adjusted net debt, which at the half year was GBP 10.3 billion. Adjusted net debt to EBITDA was 2.6x, down from 2.7x at the end of September and from 3.5x at the end of March last year. We remain focused on reducing leverage towards the lower end of our 2 to 2.5x target range. These are a solid set of results, and the business continues to perform well despite some short-term COVID-related changes to buying patterns. The business benefits from high margins and a strong track record in managing cost inflation, further supported by its ability to take pricing. We are well placed to fund investment in the new strategy whilst also strengthening the balance sheet and reducing leverage, which will underpin our investment-grade rating. The cash fundamentals of the business remain strong, supporting the delivery of attractive and reliable future cash returns. I will now hand you back to Stefan.

Stefan Bomhard: Thank you, Oliver. It is less than 4 months since we set out our new strategy. And while it is still early days, we've made some good initial progress on implementation, and I'm pleased with the way employees are embracing change. I will cover our progress here and touch on our operational performance before summarizing priorities for the second half and the outlook. As a reminder, our strategy is built around 3 strategic pillars and 3 critical enablers. Today, I will give an update on some of the key actions we're taking to deliver the strategy. I will start by outlining our focus and initial progress on the operational levers in tobacco. The tobacco business has the potential to deliver a strong performance, and my view of the value creation opportunities in tobacco remain clear. We've also continued to take important steps to reset our NGP investment by focusing on our existing market strongholds and preparing for the market trials later this year. This is about building a successful NGP business, supporting our commitment to harm reduction. To support delivery of the new strategy, we also need to make some changes to the way we operate, improve our culture and strengthen our capabilities, and we've made some important early progress in these areas, too. So let me start with our combustible tobacco business, where greater focus and better execution creates the greatest opportunity for value creation over the next 5 years. From a tobacco market perspective, at our Capital Markets Day event in January, we outlined our detailed plans with clear operational levers for each of our 5 priority markets

Operator: [Operator Instructions]. Your first question today comes from the line of Gaurav Jain from Barclays.

Gaurav Jain: I have three questions. One is on the leverage. So clearly, you have benefited in 1H from -- because of foreign exchange of almost GBP 700 million, which is on Slide 15. The leverage is coming in lower than what we thought, so how does that impact your view on when share repurchases could happen? And how are rating agencies looking at your leverage right now?

Stefan Bomhard: It's Stefan. Number one, we're pleased with the progress we're clearly making on deleverage, but I'll give it over to Oliver to walk you through the details.

Oliver Tant: Yes. Thank you, Gaurav. You're right to say we're obviously very pleased with the deleverage progress in the first half. But I think we lose track of the fact that part of that has been benefit of what's happened from a currency perspective. So the 25% of the impact on our net debt balance of about GBP 700 million has been because of the strengthening of sterling and the impact that's had in the context of the value of that debt. The underlying level, of course, has also benefited in terms of levels of cash generation from the proceeds that have come from the sale of our Premium Cigar business, which benefited the period as well. If we look at the underlying momentum, it's very much in line with the trajectory that we set and talked about at the Capital Markets Day earlier on this year. And I think as a group of analysts, one should sort of take comfort in the fact that we're delivering absolutely in line with that expectation around when we get to the position when we hit our target is consistent with where we were earlier on in the year.

Stefan Bomhard: And I think I would just emphasize that last point from Oliver, it is about what you should see now in this half year is the deleverage being delivered that we talked about at the Capital Markets Day.

Gaurav Jain: Sure. My second question is on Pulze and the launch which is happening later this year. Now we are seeing some patent litigation between some of the companies and the sector around heat, not burn, technology and product. How are you approaching those sort of issues? And what if they happen, and how would you handle that when you launch Pulze?

Stefan Bomhard: Yes. I think one thing which is good, I mean we -- one thing which is important to know that our Pulze product in its basic form has been in the marketplace in Japan, yes, without any litigation challenges for an extended period of time. Yes, so I think that gives us comfort that, to our best knowledge, our launch in Europe shouldn't be impacted by any litigation on this front.

Gaurav Jain: Okay. And on heat-not-burn, so look, there are tax gap between cigarettes and heat-not-burn products currently everywhere in the world, including in Europe. And in a market like U.K., which you are really not prioritizing for your heat-not-burn launch, one can argue that, that difference actually negatively impacts your cigarette business. So do you think the tax gaps are too wide in certain markets and should close?

Stefan Bomhard: Sorry, Gaurav, I think it was just -- I was trying to understand the question is about the attractiveness of certain markets for heated tobacco, correct?

Gaurav Jain: No. What I'm trying to understand is that in some markets like the U.K., these tax gap between heat-not-burn products and cigarettes, they actually negatively impact you if consumers keep moving to heat-not-burn products in the U.K., where you are not present. So would you be aiming for the closure of these tax gaps over the long term?

Stefan Bomhard: Okay. I got it. Sorry. Reality is I think one of the things, our strategy around our NGP strategy overall, like with the rest of the industry, is built around the fact that governments across the world will incentivize in their tax regime for consumers to switch over to NGP products, yes? I think there is a level of robustness to the strategy that it isn't built around some specific exact position of a government to take. So I feel, and to be clear, I think there will continue to be movements around tax rates around NGP products across the world in the years to come, yes. Overall, what we've seen is -- the direction is in line with what we expected. And I -- when we formulated in January our strategic plan, yes, we did foresee an increase in tax rates related to NGP products. So we have seen nothing in the last couple of months that would worry us in this context.

Operator: And your next question comes from the line of Adam Spielman from Citi.

Adam Spielman: Three quick questions from me. Just returning to share buybacks, can you just really make it simple for us? When should we expect share buybacks? And also, have the rating agencies put more pressure on you in any way because of the possibility of the menthol ban in the U.S.? That's the first question.

Stefan Bomhard: Adam, let me answer it, and Oliver will jump in with more details. I mean in principle, in the Capital Markets Day, I think we outlined very clear what is our capital allocation policy, yes. And I think what you should look at the results today, we are delivering against the deleverage that performance at this point in time. I think in Oliver's answer to Gaurav, I think one is to say I would just be mindful of that there can always be moving pieces around it. I think therefore, we do not want to give a forecast when we'll get to that deleverage level that we have targeted. And I hope for your understanding on this one, yes. On your second question on the rating agencies, to be clear, we are in constant discussion with the rating agencies. What we have outlined as our strategy is very much in line with the discussions we had with them to protect our credit rating in this context.

Oliver Tant: And I mean, Adam, just the point about pressure, you'll see that all 3 rating agencies are now stable outlook. So we've actually improved the position over the past few months or so where we were on negative watch, I think, partly as a result of the uncertainty around our future given the arrival of a new Chief Executive and a new strategy. But that has now been addressed in their ratings, and we are on stable outlook on all three rating agencies who assessed.

Adam Spielman: Okay. My second question is sort of about sort of innovation for next generation products. I noticed you're very much talking about that you need to connect, have more in the notional connection with consumers. But you don't talk anywhere about product upgrades. And I'm well aware that PM and JTI and BAT are investing on [indiscernible] invested a lot of money, hundreds of millions in upgrading their products. And so I'm just wondering, in this category, do you really believe that emotional connection is enough? Or because as either business, I think your products just need to be really substantially better, and that's going to be very expensive.

Stefan Bomhard: Sure. Adam, I think you're absolutely right. I mean to be clear, the mission is not -- it's just an emotional connection. I think, look, being a marketer by training, yes, it's a combination of your product offering with your marketing program and your emotional connection and, to be clear, also your route to market, where can my consumers buy my product at what price, yes? So it's the whole marketing mix, yes? So I think what we wanted to highlight is that, historically, we have very much relied on our product offering being -- carrying our message. And I think with the arrival of Andy and really having a marketeer sit at the top team of Imperial, we want to up-dial our -- the quality of marketing communication with our consumers. But to be clear, product and product innovation will continue to play an important role. The second point I would want to make here, and I think it's an important one to keep in mind, is we are the #4 player in the world, our ambition is not to be the market leader in NGP, yes. And our strategy now really focuses on NGP countries where there is a sizable NGP segment, where consumers are increasingly looking for choices, yes. So in principle, our assessment is we can compete for the market share that we are looking for as part of our strategic plan in these markets with what we have to offer. But to be clear, part of our market tests, the trials that we're planning for NGP, meaningly, specifically our vaping product in the U.S. and our 2 European heated tobacco markets, is to validate our proposition.

Adam Spielman: Okay. And then finally -- okay. Well, finally, sort of I want to see about your brand strategy in tobacco. And it seem to be very much focusing on the comparative trends. And in the context of the history of the last 20 years in tobacco, that's a very unusual trend, where the growth has all been and the move has all been towards international brands. Obviously, you have seen stronger competitive brands. But do you think you can continue like that? Is this a sort of perpetual strategy that now what everybody else is doing towards international brands and purchasing more and more on that, you will be pretty much the sole player who's focusing on local heritage brands. Is that how you see it going forward for many years?

Stefan Bomhard: Yes. Adam, thank you for the question because I think it allows me to clarify one point is it is a combination of focus on global brands and local brands, yes? The difference is -- and therefore, we do not drive a strategy that is focused solely on local brands. The strategy is, and this is the strategic change. We have completely neglected local brands in the last couple of years. Our level of investments in local jewels has been negligible. They were excluded from any -- receiving any support from an innovation side, for example, and major marketing spend. And that, we think, is a mistake. If you're really consumer-centric, given the history of our company, we actually have a disproportionate share of strong local jewel brands, given our acquisition history. And what the strategy has corrected, instead of giving no money to them and trying to migrate them as hard as possible into global brands, we've put the consumer first and saying we will continue to absolutely -- priority #1 is our global brands, yes, but we are now supplementing that with selected bets on local jewel brands. And you can see in these set of results, if I may, in the market share performance, two markets in our top 5 markets have grown share in U.K. and Spain. A very substantial part of that share growth has been our reinvestment in local brands in Spain in Nobel and in Fortuna and in the U.K. into the launch of Embassy. So actually, we can see in this set of results the first green shoots of actually starting to reinvest in some selected local brands. But that is not that we will not stop -- that will not invest our global brands. So it's a combination of the 2.

Adam Spielman: Okay. That was my last question.

Stefan Bomhard: Thank you, Adam.

Operator: Your next question comes from the line of Alicia Forry from Investec.

Alicia Forry: Two questions. The first one is on Australia, which has, I guess, struggled to turn around as quickly as some of the other markets for the reasons you identified. My question is, do you think that you have the correct pricing architecture for that market longer term? And then secondly, on the U.S., can you talk a bit more about what gives you confidence in the U.S. vapor for a turnaround after competitors have obviously made a big push there in recent months? Just would appreciate a bit more color on how you think you can regain some of that lost share.

Stefan Bomhard: Yes, very good question. On pricing architecture, Australia, I have the confidence that we have the product lineup and the pricing architecture to compete effectively in the Australian market. And let me explain that better. The share loss you see reported in the half year results for Australia is primarily driven by our decision to increase prices and pass on duty excise to consumers and to customers. However, some of our competitors have chosen not to do that. And especially at the lowest entry, the fixed price here in the market, we became uncompetitive. So all our share losses are related to that specific price tier. We have now, in the last couple of months, taken corrective steps to actually -- and we have very quickly started to recover that share. So I feel quite confident that there's nothing problematic from a consumer perspective behind our brand architecture or pricing architecture. It was a very clear choice that hopefully will fill you with confidence that we're not here buying our shares. We're actually here pricing more than our competitors at the beginning of this fiscal year, yes? So that hopefully gives you some confidence we have the right product hierarchy, we have the right pricing architecture to actually compete in the Australian marketplace. To your second question about the U.S. on NGP and specifically blu, we will have our market test in the United States and in one area of the U.S. where we'll test the whole proposition, yes, which is primarily a reset of our marketing and route-to-market capabilities, yes? So we do believe that with these 2 key marketing elements being reset, we absolutely have an opportunity to compete in the U.S. market. But I would come back to one point. We are the #4 or #3 player in the U.S. market, where you look at it, 4 in NGP, 3 in tobacco. Our ambition doesn't have to be to be number one and number two to make money in this marketplace. So that's an important piece to keep in mind. When you look at our ambition, it is linked back to what is the right ambition for this company, yes? And the last point I would make here on NGP is some of the market share movements, as you -- when you look very closely, are driven by very heavy discounting of devices down to $0.99. And you have to question yourself, I believe, you will get good to initial trial, I think you will see where the consumers stick with the brands once pricing moves up and what kind of loyalty you're buying with deep discounting of devices, which is a technique we as Imperial have not engaged in and have deliberately accepted some market share loss because we're not sure this is good market share.

Operator: Your next question comes from the line of Patrick Folan from Redburn.

Patrick Folan: Two questions, please. First, on Germany, I was hoping you can give more detail on what is happening from a portfolio perspective that is causing the current headwinds. Is it more branding focus or a portfolio that needs to be moved towards value formats? And has there been any improvement in East Germany, where prices are a bit more competitive? Or is that really dependent on your sales improvement that is ongoing?

Stefan Bomhard: Yes. Patrick, if you look at East Germany -- I'm very happy about your question. If you look at it, one thing, we still lose share in Germany, very clearly, but we lose less shares than we used to do last year. So we've lost share in Germany for 10 years in a row. So what I take is an encouraging signal, we're slowing the level of decline. Now it's very clear, that's not where we wanted to be midterm, but it at least shows some first green shoots that the initial actions are starting to show some benefit. Now just a specific part of your question, what we are seeing is our sales efforts are starting to make -- are starting to begin to make it different, but we're at the relatively early stages here, yes. Our brand renovations, reinvestment in brand equity in JPS and in Gauloises at the early stages. So the arrival of Andy, who is now deeply involved for viewing the marketing programs, will only start to make a difference over time, yes. To the question of East Germany, where we historically hold a lower share than in our national market, now one thing that has hurt us with the border closures, towards the Czech Republic and Poland because of COVID, the East German market has actually become more important. Therefore, it actually has a negative impact on our overall market share because, suddenly, the East Germany is a higher weighting of the total German share because consumers do not travel into Poland and Czech Republic at this point in time. There, it's primarily about rejigging our sales force, yes? We are building a better coverage of East German outlets, but that is just work in progress. So in summary, you can see the very early signs of our new strategy being put in place in Germany, but it's probably the place where we'll take the longest. But when I look at it, the steps we've taken, they are starting to show the results we're looking for, but there is a lot more to come especially on the brand side.

Patrick Folan: Okay. That makes sense. And just with regard [indiscernible], you talked about a Dutch menthol leaf brand extension, considering the current menthol situation, does that make sense? Or are the cigars more geared towards pure tobacco flavor as opposed to flavors that could be at risk of being banned?

Stefan Bomhard: Sure. Patrick, good question. The key motivation for us, and I'm very happy about the question, is if you look at it, we have, for a long period of time a very good position in the mass market cigar segment with Backwoods. But it's very clear, Backwoods is a very premium priced product, price at double the typical price of the market. And we have good consumer, I'm saying, so decision, as we outlined in the Capital Markets Day, we'll really see mass market cigars as a very attractive segment. It's a growing segment in the U.S., but we have only played the premium end. So the decision we have made of really serving all our consumer needs, to position a new product offering under the Dutch brand name in the price segment below. So it's meeting a consumer need that we as Imperial haven't served in the past and the initial success with the quality we can offer has been very strong to consumers. So we haven't linked it really to any potential bans on flavored cigars. It's just us going into a price segment where we as Imperial really haven't played, and the initial reaction has been quite strong.

Operator: [Operator Instructions]. Your next question comes from the line of Sanath Sudarsan from Morgan Stanley.

Sanath Sudarsan: Stefan, Oliver, the team, two questions from me, please. The first one, you have called out about share gains in combustibles across 3 of your strategic markets, U.S., U.K. and Spain. Can you perhaps give us more sense about your performance in these markets across the overall nicotine user base, just to calibrate how the movements of NGP is working in these key markets? And then secondly, Stefan, you have announced your intentions a few times today on meaningful harm reduction. Could I press you a bit on what, in your view, is meaningful here, please?

Stefan Bomhard: Sure. On total nicotine market shares, happy to look at the stock markets. Now the easy ones are simple. If you look at Spain, for example, I mean there's a relatively small NGP segment. And actually, we hold the leading market share in vaping, which is the largest category here. So actually, I'm very encouraged when I look at total nicotine share because we shouldn't forget we lost share in Spain for a long period of time. And the refocus on Nobel and Fortuna as local jewels complementing our global brands like West and JPS are actually striving share forwards. Very happy with that. If you go to Germany, reality is here, we are holding our share in the NGP segment behind vape, behind blu in a very good way. And I think we'll need to see what happens with oral nicotine team with the legislation on this front, yes. So overall, the challenge in total nicotine in Germany is clearly on the tobacco side, yes. Dealing with the U.S., reality is, as you know, when you look at it, the NGP share overall of total nicotine consumption is just progressing, as would have done in the past. And therefore, our U.S. test to get more of our fair share in the vaping segment is the key thing that we're working on. So I see -- I feel our -- what we're doing behind our new strategy to get to the right share position in the U.S. is absolutely right because we're now starting to grow faster on our tobacco share, and at the same time, we're addressing with the market trial how do we compete in the vaping segment, yes. And then to round it off, U.K., you've seen a very strong performance. Also our vaping proposition is doing quite well. And the heated tobacco segment tends to be quite small at this point in time, so I think also happy about our total nicotine proposition there. And I'm just trying Australia, as you will know, there is no legal NGP offer, so we're really talking about the tobacco position there, yes. So hopefully, that gives you an idea where we are there. Can you just remind me of the second question, please?

Sanath Sudarsan: No, sure. So I wanted to understand is your definition of meaningful harm reduction, what does meaningful quantify as?

Stefan Bomhard: Yes. Yes, I think to be clear, it's to -- would probably be better placed once these market tests have completed. I think what you definitely read into it, we do believe we -- as one of the large players in our industry, we want to make the right contribution in offering our consumers a harm-reduced product offering, yes. I wouldn't want to put a number at this point in time because we're talking about a market that is still highly volatile, still in development, yes, but it will make a meaningful difference to the harm reduction for our consumers. It will also, over time, hopefully make a meaningful difference to our financial situation as a company.

Operator: Your next question comes from the line of Jon Leinster from Societe Generale.

Jonathan Leinster: Yes, three, if I can. First one, just on the sales force expansion in the U.S. and Germany, is that -- has that already started within the U.S.? And is that going to be something that's really coming into the second half of this year and therefore should start to have an impact next year? Or what could you give, perhaps a time line on when you expect the results of that expansion, please?

Stefan Bomhard: Absolutely, Jon. You got it. In principle, what's happened in half 1, we have primarily prepared. Recruitment has happened. But as you will know, if you want to recruit people in the right way and they are going through training right now, so virtually, these new colleagues will hit the role and customers, yes, in the half 2 in U.S. and in Germany, yes. Reality is when they go after new territory, we shouldn't forget these are customers that we haven't covered with face-to-face interactions. So probably the financial -- put it this way. The net revenue impact in the second half is going to be smaller, but it will be an investment in the second half because the salaries of our new colleagues are in there. You will see the benefit from a market share perspective most likely more in fiscal year '22 when they have found the right routes, they've built a relationship with the customers, they have put the right picture of success and shelving out there. So that's how I would see you being able to track the progress we're going to make.

Jonathan Leinster: Okay. Second question, maybe I misheard you, did you say your mass market cigars in the U.S. were up 60%, 6-0?

Stefan Bomhard: No, you haven't misheard us. It's actually up 61%, yes. Before we get too carried away, I think just to help you, Jon, now number one, the big brand in there is Backwoods. Backwoods in half 1 2020, so the like-for-like comparison period, we suffered supply chain issues because we really want to make sure the quality of the leaf is correct, yes. And we have seen such an increase. So actually, last year, we really struggled with supply. So the plus 61% is logically -- was helped by that fact that the base was quite low. It is also helped, to be clear, by the launch of Dutch that we touched in one of the questions before, where you have the pipeline filling effect of that as well as retail partners actually give us extra shelf space and stock the brand, yes. So please do not expect a repeat of that in half 2, yes. We still have a positive number. And I think you should probably see the bigger picture is that there's a segment that actually is in growth overall, yes, in volume. We as Imperial have the strongest brand in that segment. We're building out our portfolio. We're getting to a supply chain situation that actually will allow us over time to meet consumer demand. So this should be one of the growth engines of our U.S. business for the years to come, and it's clearly baked into our overall global strategy.

Jonathan Leinster: Actually, apologies. The question was actually going to be, I mean given that level of growth, do you actually have the capacity to maintain that sort of level of that sort of significant growth rate that you've seen? Or is that something where you have to invest quite a lot more in order to maintain that sort of growth?

Stefan Bomhard: We have made the investments. And to be clear, the leaf supply is kind of independent farmer. So this isn't a CapEx investment from Imperial side, the manufacturing capabilities we absolutely have, yes. We will be able to actually grow the brand in the way we have forecasted. The only thing, please do not expect it to grow 61% year-on-year, that would be the key thing, but expect to see good positive growth, hopefully, over time, also double-digit growth behind the brand proposition here.

Jonathan Leinster: And lastly, the -- obviously, you had a settlement with Minnesota and Texas. Does the provision cover -- is that all the outstanding disputes with the U.S. states? Or is there potentially more to come in terms of that provision for the MSA disputes?

Oliver Tant: Well, the answer is it's just covering Texas and Minnesota. We do have litigation with Florida which is ongoing, but we are extremely confident about our position with Florida, which is why we -- you will see there's no provision in the context of where we sit with that particular litigation. So it doesn't cover everything, but it covers the areas which we thought it was sensible to settle upon based upon where our position is at the moment.

Operator: We have one further question, and the question comes from the line of Faham Baig from Credit Suisse.

Faham Baig: Following the trend, three from me as well, please. Can I start quickly with the mass market cigars business? Stefan, you mentioned it's in volume growth. What do you think is driving that performance? Will be helpful. And just on that, has there been a price increase? I know one of your competitors announced a price increase at the start of the year. Have you also taken a price increase there? That's the first question.

Stefan Bomhard: Okay. Absolutely. Number one, why is mass market cigar in growth for us are 2 drivers. The biggest driver is our market share gains. I mean we have gained very significant market share in that category, yes. That's the #1 driver. What -- a smaller effect is that it is -- when you look at total nicotine consumption in the U.S., it's actually the one segment that actually is growing nicely as consumers are switching to this product offering in the marketplace, yes. And on the question on price increases, we are the most premium priced product in the marketplace with Backwoods, with double the price of the next competitor, so actually, we have not taken some specific pricing on this, yes. So pricing has not been a key driver disproportionately for -- contributing to the 61% growth.

Faham Baig: Okay. Perfect. And then moving on to modern oral or nicotine pouches, could you remind us how big that business is for you guys now? And could you maybe help us with the strategy in modern oral specifically? And I know you mentioned you have some market trials in the other 2 NGP businesses. But what is the strategy here? And what could lead you to potentially changing your view on taking oral nicotine in the U.S. where you would have a very good route to market, and clearly, there is a potential benefit from a return standpoint as well in that market?

Stefan Bomhard: Just to give you an idea, our modern oral nicotine business roughly in these numbers are GBP 50 million business, just to give you a dimension. It's meaningful, but logically, it's warped by the EVP business. Now to be clear, one thing we've -- it's a very fair question about the U.S., but I think we should step back and look at a bit. We have a very strong position in our European markets, where the brands are well established, and there is a consumer habit for that. So you're very right to point that, the only market where there is a well-established oral nicotine segment where we're not present in the U.S., yes, absolutely right. But you will know well, to launch a new brand into the U.S., you will have to go through a very lengthy PMTA process unless you are going to buy a competitor in the U.S., which we've chosen not to do. I think we have big opportunities for us as a company. But we'll see how this progresses over time. But the GBP 50 million, we think there's a bigger opportunity for Imperial to compete in the much larger vaping sector.

Faham Baig: Okay. And just one final question. I think you mentioned this on the slide deck. Your share in the top 5 markets was up 6 basis points, but actually, your tobacco share overall was up 30 basis points. What markets are making that difference? And is it you driving that performance? Or is it an issue of portfolio, and which markets in particular are driving that would be helpful to understand.

Stefan Bomhard: Sure. One of the biggest drivers is that our top 5 markets exactly a year ago lost 37 basis points, yes. So actually, the biggest improvement here is actually our core markets. Now if you look at why are the wider markets still show better share gains a couple of markets which are big volume markets because we're talking volume share. You're talking markets like Saudi Arabia, yes. You're talking markets like Russia in our portfolio. There are a couple of markets that actually where we have good market share performance. But if we go back to strategy, these are not markets where we as Imperial make good lots of money. So that is one of the things. But I think what is reassuring for you is about the focus on the top 5 markets hasn't slowed down some of the other markets in our market share position. And the other one in this one, just to complete it, our African markets, which we highlighted about the strategy also had some very good share performance, which is probably of all of them the most important one because they are strategically not within the top 5, but not too far behind, which should also -- which gives us confidence about our strategy in the longer term.

Operator: Your next question comes from the line of Jon Leinster from Societe Generale.

Jonathan Leinster: Back again, sorry about that. Just a quick question. On the first 6 months, you mentioned that total market size was down 3.2% and, obviously with COVID sort of unwinding, would you expect the market size to be down for the full year, please?

Stefan Bomhard: Yes, it's a tricky one, yes. And just to share that dilemma you, I think when you look at it, overall market size has been slightly helped by the COVID situation, yes? As COVID kind of starts to unwind, I think we'll see more of a return of volume market declines back to historical levels. But I think the challenge for all of us at this point in time, when you look at our half two being April through September is quite tough at this point in time to forecast how much you will start to unwind in these next couple of months, primarily be fair based about travel restrictions, yes, the ability of consumers to return back to their normal consumption patterns. So if you ask me today, I would say you will see a slow return back to normal consumption patterns and, therefore, normal market decline rates from a volume perspective. But I don't think you will see in half 2 a complete return to a normal pattern yet.

Operator: Your next question comes from the line of Jay Dinges from JPMorgan.

Jared Dinges: Actually, all my questions have been answered, but maybe just one quick one. So in the U.S., for a while now, we've been seeing some down-trading from kind of the premium discount segment to the deep discount segment. Is this something that you guys would expect to continue? And are you kind of adjusting for that and planning your strategy around that? So maybe if you can comment on that one.

Stefan Bomhard: Yes. I mean one thing is consumers -- I mean we've been more consumer-centric as a company. I think it's important we follow and want to serve our consumers wherever they are. I think one of the things which is exciting for us as Imperial, while we're only the #3 player in the U.S., we do have an attractive offer in the deep discount segment, yes. So one thing I think that distinguishes us in the U.S. is about of all the big players, we're the one with the most complete assortment of brands going from premium all the way down to deep discount, yes. So the ability to serve our consumers, and you're right, if there is a segment that has grown in the last couple of years slightly ahead of the rest of the market, it's that deep discount segment, yes, which we do serve as well as a brand and has helped us on our share development, yes. So that is something I'm very happy with. And when we look at now with Andy arriving as our new Chief Consumer Officer, we're looking about what offer, what brand offer do we have for what price point in the U.S. market, yes? And you will be aware that the deep discount segment in the U.S., despite its name, is still a very attractive segment for industry players like ourselves from a cross-margin perspective.

Operator: Thank you. I will now hand back the call for closing remarks.

Stefan Bomhard: Okay. Sure. I mean, first, thank you for a set of great questions. So hopefully, you get a good sense, yes, about kind of a good start into the year, good top line performance, really happy especially being able to stabilize our market share in our top 5 markets, yes. And looking forward to a good year, but I think it's good to have the first half year under our belt, and I just want to reiterate the guidance that we gave for the full year, yes. And hopefully, looking forward to seeing you, when we do the full year results, face-to-face. None of us are giving up hope on that one, yes. All right. Take care.

Operator: Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.