Philip Morris International Q3 2022 Earnings Call Transcript

Quartr
Provided by Quartr
October 20, 2022

Key Takeaways

  • IQOS US Control: PMI will regain full control of IQOS in the U.S. from April 30, 2024 by paying Altria ~$2.7 billion, enabling a full‐scale launch to target a 10% market share of cigarettes+HTUs by 2030 with an attractive ROI thanks to no legacy cigarette business.
  • Strong Q3 Performance: Q3 pro forma shipment volumes grew +2.3%, organic net revenues +6.9%, and adjusted diluted EPS (pro forma) reached $1.33 (+8.3% currency neutral), driven by 22% HTU volume growth and ~5% combustible pricing despite inflation and supply‐chain headwinds.
  • Revised Full‐Year Outlook: 2022 guidance raised to +2–3% shipment volume and +6.5–8% organic net revenue growth, though adjusted operating income margin is now expected to be flat to slightly negative due to higher energy, material and logistics costs, with pro forma EPS still forecast to grow +10–12% to $5.22–5.33 (ex‐currency).
  • Global IQOS Momentum: Estimated ~19.5 million IQOS users (+0.5 million in Q3); HTU category share ~75% in IQOS markets; record sequential IMS volumes; Iluma rollouts in Europe, Japan and emerging markets drove ~30% of pro forma HTU growth in Q3.
  • Swedish Match Offer Update: PMI raised its bid to SEK 116 per share (52.5% premium) with a 90% acceptance condition to secure full synergies in the U.S. smoke‐free segment, calling this its best and final price.
AI Generated. May Contain Errors.
Earnings Conference Call
Philip Morris International Q3 2022
00:00 / 00:00

There are 9 speakers on the call.

Operator

Good day, and welcome to the Philip Morris International Third Quarter 2022 Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by Philip Morris International Management and the question and answer session. Media representatives on the call will be also invited to ask questions at the conclusion of the questions from the investment community. I will now turn the call over to Mr. James Bushnell, Vice President of Investor Relations in Financial Communications.

Operator

Please go ahead.

Speaker 1

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2022 Q3 results. You may access the release on 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.

Speaker 1

S. GAAP measures and additional smoke free volume and net revenue data or at the end of today's webcast slides, which are posted on our websites. Unless otherwise stated, all references to IQOS are to our IQOS heat not burn products and all references to smoke free products are to our RRPs. Growth rates presented on an organic basis reflects currency neutral adjusted results, excluding acquisitions and disposals. Figures and comparisons presented on a pro form a basis entirely exclude PMI's operations in Russia and Ukraine.

Speaker 1

As mentioned previously, starting in the Q2 of 2022 and on a comparative basis, PMI excludes amortization and impairments of 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 I'm joined today by Jacek Olchak, Chief Executive Officer and Emmanuel Babbo, Chief Financial Officer. Jacek will join us for the question and answer session. Over to you, Emmanuel.

Speaker 2

Thank you, James, and welcome, everyone. Today marks a historic day in our journey towards a smoke free future With the certainty that we will have full control of IQOS, the world's leading smoke free product in the United States, Agreement with Altria removed the potential of a protracted legal process to regain the U. S. Right to IQOS, which Altria previously held, subject to performance milestone until 2029. We have ambitious plans for the full scale launch and rapid expansion of IQOS In the U.

Speaker 2

S. Market, as soon as we take over an efficient time during the transition period to put our commercial model And related organization and infrastructure in place using our wealth of experience from international markets. We see IQOS as the primary vector for establishing a leadership position in the U. S. Smokefree industry and it will be followed by the other product in our smokefree portfolio.

Speaker 2

In this context, Swedish Match offers an immediate position in the overall segment and mutually beneficial synergy at salesforce level. However, should the offer fail, we can certainly build a robust sales force as part of our commercial deployment engine during the transition period. Under both scenarios, we see an accelerated path to profitability with an attractive payback period on our IQOS investment, given superior U. S. Unit economic and the absence of a legacy cigarette business.

Speaker 2

I will cover this in more detail later. With regard to Swedish Match, we announced This morning, an update to our offer with our best and final price of SEK 116. Our updated offer retained a 90% acceptance condition, which is critical to allow us to capture the full potential of the combination. Now that we are close to the end of the offer period, the increased offer is primarily intended to fairly reflect The higher net value to us of the portion of Swedish Match cash flow, which are in U. S.

Speaker 2

Dollars given currency movements since our initial offer was announced in May. Equity markets, the global economy and interest rates have also moved unfavorably since then. As such, we believe the updated price with a premium of 52.5% To the undisturbed share price prior to the initial offer, strengthen the attractiveness yet further for Swedish Match shareholder, while maintaining strong Value creation for PMI shareholders. This is our best and final price, and we hope to complete the transaction next month to achieve Turning now to our Q3 earnings. We delivered another very strong performance this quarter with HTU volumes ahead of our forecast and robust growth in total volumes, market share and combustible net revenues.

Speaker 2

With adjusted operating income margin in line with expectation, This resulted in total Q3 adjusted diluted EPS of $1.53 close to our all time high quarterly high despite notable currency headwinds. IQOS' excellent performance continued with plus 22% growth in pro form a HTU shipment volume, a testament to the continued strengthening of our heat not burn portfolio and broad based growth across key regions. IQOSILUMA continued to drive growth in its launch market. In combustibles, we delivered robust performance with Q3 organic pro form a net revenue growth exceeding plus 4%, driven by accelerated pricing of almost plus 5%. Cigarette shipment volume were essentially stable and category share grew supported by Marlboro, showcasing the resilience of the brand despite current economic conditions.

Speaker 2

Turning now to the headline numbers. Our Q3 volumes grew by plus 2.3% on a pro form a basis and by plus or 0.6% in total, including Russia and Ukraine. Pro form a net revenues grew organically by plus 6.9% and by plus 6.7 percent for total PMI. Our total organic net revenue per unit Grew by plus 4.5 percent on a pro form a basis and by plus 6.1 percent in total despite lower device revenues. This reflects the increasing weight of IQOS in our sales mix and a step up in combustible pricing.

Speaker 2

Our Q3 adjusted operating income margin declined organically by 100 basis points on a basis and by 90 basis points in total, consistent with our expectations. As previously communicated, this reflects the recovery in device volume the investment in launching Illumina, including initially higher unit costs The impact of supply chain disruption, notably due to the war in Ukraine and increasing global inflationary pressures. Despite these headwinds, our strong top line growth and ongoing cost efficiency enabling us to outperform our previous currency neutral guidance to deliver adjusted diluted pro form a EPS of 1.33 including unfavorable currency of €0.23 representing plus 8.3 percent currency neutral growth. Including Russia and Ukraine, we delivered adjusted diluted EPS of 1.53 Our strong Q3 combined with a robust H1 supported an excellent delivery for the year to date. I would highlight our strong pro form a volume growth of plus 3.4 percent and organic net revenue growth of plus 7.7 percent, again reflecting continued strong IQOS performance, pricing and the recovery of the combustible business in many markets against a pandemic affected comparison.

Speaker 2

Smokefree net revenue made up around 30% of our year to date pro form a total, putting us on track to reach our ambition of over 50% by 2020. Our year to date operating income margin Contracted organically by 110 basis points on a pro form a basis, driven by the factors mentioned previously. We remain on track to deliver cost savings of $2,000,000,000 over 20 20 onetwenty 23. $1,500,000,000 of gross savings have already been delivered, including over $200,000,000 in Q3. This allows us to invest in the business and mitigate increasing inflationary pressures.

Speaker 2

Year to date, currency neutral adjusted diluted EPS grew by plus 9.7 percent to 4.11 on a pro form a basis and by +8.8 percent in total to $4.59 an excellent performance. Now let's turn to the pro form a full year outlook. Given the continued growth of IQOS and robust trends in combustible. We are revising our top line forecast upwards to plus 2 to plus 3% growth in total shipment volume and plus 6.5% to plus 8% growth in organic net revenues. While our top line outlook remains very strong, like many other global companies, we are facing significant inflationary forces in the world economy and this is reflected in our updated adjusted OI margin forecast.

Speaker 2

Inflation in our cost of goods remained mid single digit in the 3rd quarter. However, Inflationary pressures are growing as we renew pricing arrangements, notably for certain direct materials, wages, Energy and transportation costs. In addition, the very strong growth of Illumina in Japan and other launch markets As an initial negative margin impact given the higher weight of the consumable and increased cost of both the device and consumable in the 1st 12 to 18 months of activation. As mentioned previously, the combination of strong demand, Global supply chain disruption and the impact of concerning induction HTE production in Russia means our supply chain is not fully optimized. This has resulted in reduced productivity and a number of additional costs, including an approximate $300,000,000 impact from a significant increase in the use of airfreight.

Speaker 2

As a result, while we continue to expect a rebound in our Q4 adjusted OI margin, partly reflecting higher commercial investment In the prior year, we are now forecasting less expansion than previously expected with pro form a adjusted organic Operating income margin flat to slightly negative for the full year. Despite this change to margin expectations, Our top line momentum is strong, and we continue to forecast pro form a adjusted diluted EPS growth of plus 10% to plus 12% for 2022. This translates into a pro form a adjusted diluted EPS forecast of $5.22 to $5.33 including an estimated unfavorable currency impact of $0.87 at prevailing rates, notably due to the euro and Japanese yen. There is a slide in the appendix with further detail on the For total PMI, which assumes a full year contribution from Russia and Ukraine, We expect adjusted diluted EPS of almost $6 including an estimated $0.80 unfavorable currency impact. Lastly, given the continued success of Filuma and the constellation of Terrier production in Russia, I just referenced, we are working to further accelerate our production of induction consumable.

Speaker 2

As we convert and transition capacity from blade to induction, we incur certain inefficiencies and limits on the availability of Illumina HDUs. We are optimizing our inventory level where possible to minimize any impact on consumer availability. However, these factors are a constraint on our shipment, and we are updating our HTU shipment volume forecast to 89,000,000,000 to 91,000,000,000 units for the year. Importantly, this is a short term supply dynamic. Consumer of tech trends remain strong and HTU in market sales volume are expected to further Accelerate their growth to over plus 25% in Q4, while also growing sequentially compared to Q3.

Speaker 2

The cash generation capacity for our business remains exceptional as shown through the challenges of recent years. Our balance sheet and cash flow remains strong. We delivered operating cash flow of $7,700,000,000 year to date, representing growth of +6.5 percent on a currency neutral basis. Today, we reconfirm our forecast of around $10,500,000,000 in operating cash flow for the full year despite an estimated currency headwind of around $1,300,000,000 This means we expect to deliver an excellent $22,500,000,000 over 2021 2022. Cash flow was flat somewhat in 2021 by $500,000,000 from one off impact and the timing factors of certain cash flow, which benefited 2021 at the expense of 2022 and by a further $500,000,000 of working capital improvement.

Speaker 2

However, our 2022 forecast demonstrates underlying growth against this exceptional year. I would also like to highlight that U. S. Dollar strength has a positive impact on our net debt, given that more than 60% of our financing is in euro, including derivative overlays. This serves to offset the impact on our earnings and combined with strong cash generation contributed to $1,500,000,000 reduction in our net debt since December 2021, which is now below 1.6x adjusted EBITDA on a 12 months rolling basis.

Speaker 2

This delivery highlights our ability to maintain a strong balance sheet, pay down debt and invest in the growth of our business. In addition, we recently increased our annualized dividend for the 15th consecutive year in line with our long term commitment to return cash to shareholders. Turning back to our results. Our total pro form a Volume increased by +2.3 percent for Q3 and +3.4 percent year to date, putting us comfortably on track to deliver total volume growth for the 2nd consecutive year on both a pro form a and total PMI basis. Pro pro form a HTU shipment volumes grew by +21.9 percent for the 3rd quarter and plus 15.8% year to date.

Speaker 2

While our shipments have been more volatile this year, reflecting the current supply chain dynamic, HTU IMS growth has been consistently strong with plus 18.2% growth in Q3 and plus 19.2% year to date with robust performance in the EU region, Japan and low- and middle income markets. As I mentioned, we expect a further acceleration of IML growth in Q4. Focusing now on combustibles. Our portfolio delivered robust pro form a organic net revenue growth of plus 4.1 percent in Q3 and essentially stable pro form a shipment volume. Our pro form a pricing accelerated to +4.9 percent in Q3 as we progressively adjust to the inflationary environment.

Speaker 2

This reflects notable contribution from Australia, Germany and the Philippines and a positive quarterly variance from Indonesia for the first time since Q4 twenty nineteen. We now expect full year pricing to be around 4%. Our pro form a share of the cigarette category increased by plus 0.2 points year to date. This was supported by Marlboro, where volumes grew by almost plus 4% for total PMI. With the premium position in a challenging consumer environment, This represents an impressive performance from the world's leading cigarette brand.

Speaker 2

Our leadership in combustible helps to maximize Switching to smoke free product, and we continue to target a stable category share over time despite the impact of IQOS cannibalization. The positive combination of stable share in combustible and the continued growth of IQOS and position us to deliver total market share growth over time. We captured plus 0.5 points of pro form a share gains in Q3 and plus 0.6 points year to date with notable contribution from Italy, Indonesia, Japan and Poland. Despite increasing competition in many markets, our leading share of the growing heat not burn category has remained stable since the start of the year at around 75% and grew sequentially in the 3rd quarter. This remarkable achievement is supported by the increasing deployment of a 2 tier HD portfolio, providing adult smokers with an expanding range of innovative and high quality alternatives to cigarettes.

Speaker 2

PMI HTUs again strengthened their position as the 2nd largest nicotine brand in markets where IQOS is present, With a sequential share gain in Q3 of +0.2. To a record 7.7% Focusing now on IQOS performance. We estimate there were approximately 19,500,000 IQOS users as of September 30, excluding Russia and Ukraine. This reflects growth of around +5000000 users in Q3 and +2,700,000 year to date. As shown on the right hand side of the slide, the Q3 of each year typically experiences slower pro form a user growth due to seasonal factors.

Speaker 2

The growth of €500,000 this quarter was very robust in a historical context, noting that the high growth in Q3 2020 benefited from a catch up effect following the relaxation of COVID restriction on retail location and mobility. Importantly, we expect a strong acceleration in user growth in the Q4 of 2022. In the EU region, smoke free net revenue comprised almost 40% of regional net revenue year to date with a number of markets well above 50%. This performance clearly shows the way towards our ambition to be predominantly smoke free by 2025. Our EU 3rd quarter HTU share increased by plus 2 point compared to Q3 last year to reach 7.3% of total cigarette and HTU industry volume.

Speaker 2

I would also highlight the plus 0.2. Sequential increase, which is a notably strong performance given the usual seasonality of the combustible market. Most importantly, adjusted IMS volume continued to grow sequentially and reached a record high of 8,700,000,000 units on a 4 quarter moving average. We expect IMS volume growth to continue in Q4 with a corresponding increase in market share. Please refer to the appendix for additional key city and market share data.

Speaker 2

With Regards to regulation in the EU, we are encouraged by the increasing number of countries adopting multiyear fiscal framework with clear differentiation of smoke free product, such as the recent legislation in Romania. We expect the proposal on the EU Tobacco Exaxe Directive As a reminder, the tobacco excise directive We require unanimous support for approval by all 27 EU member states. Now let's focus on the performance of Illumina in the EU region. Illumina continued to drive user acquisition, switching of existing user And accelerated category growth in both Spain and Switzerland. In Q3, both markets experienced another quarter of strong Sequential IMS volume growth with offtake exit volume of Teria now the clear majority of HTU sales in both markets.

Speaker 2

We also launched ILLUMA in Greece at the end of June with promising initial results and introduced the product to Portugal earlier this month. In Japan, the adjusted total tobacco share for our HTU brand increased by plus 2.8 points versus the prior year quarter to 23.6%. As in the EU, Q3 last year saw an optical sequential share decline due to combustible seasonality, making the +0.7. Sequential increase this quarter a notable achievement. IMS again grew sequentially to reach a record high of 8,300,000,000 units on a 4 quarter moving average.

Speaker 2

This was driven by the impressive performance of IQOSILUMA and the continued growth in key cities such as Tokyo. The hypnotherapy now represents over 1 third of total tobacco in Japan with IQOS increasingly driving the year's growth. Alco Siluma celebrated its first anniversary of the Japan national launch in September and continues to exhibit strong growth due to excellent conversion, consumer satisfaction and retention rates. Our premium priced Terrier HTUs continued to grow strongly in Q3 and strengthen their position as both the 2nd largest nicotine brand and largest RRP brand in Japan, reaching an exit of tech share of 14.9%. Encouragingly, Sentia HTUs have also grown rapidly since the initial launch in April and national expansion in mid July, driving consumer acquisition in the mainstream price segment.

Speaker 2

We exited Q3 with over 25 percent HTU of tech share, a record high, and continue to see a long runway of growth in Japan over the coming quarters. In addition to strong IQOS gain in developed countries, we continue to see very promising growth in low and middle income markets, which drove around 30% of the company's pro form a HTU growth in Q3. 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. Strong growth in IMS volume continued and the pro form a share of our HTU brand grew plus 0.9 points versus the prior year quarter to 2.8% in Q3, a robust performance considering the impact of seasonality. This reflects success across many markets with notable progress in Lebanon, where Q3 Oftech share in Beirut increased by plus 7 points to 18% and Egypt, where Oftech share in Cairo is approaching 6%.

Speaker 2

Further, TCT data can be found in the appendix. We are also encouraged by recent positive regulatory development in the Philippines, where the government passed a new law clearly differentiating combustible and non combustible tobacco product. Smallfield products will be regulated separately with different health warnings, permitted product testing or guided trials and rules to be established for product communication and point of sale activity that will support the switching of adult smokers to better alternatives. In addition, the latest development from our smoke free innovation pipeline is a new heat not burn device that is especially relevant for low and middle income market. It is a simple, convenient and affordable proposition, which can cater to local test preferences without compromising on the reduced risk profile of the product.

Speaker 2

We are planning pilot city launches in Colombia and the Philippines during the Q4 as we further extend our portfolio of smoke free products to serve As we continue to innovate, it's critical to integrate Sustainability through eco design principles, circularity and efforts to minimize and manage post consumer waste. Addressing the environmental impact of our product is a key pillar of our sustainability strategy, which is reflected in our sustainability index and form part of our executive compensation scheme. Our approach to reduce waste related to cigarettes, AIRP consumable device and packaging is covered in the report, case studies and campaign published last month and available via a dedicated microsite on pmi.com. For example, we are progressing well towards our 2025 Aspiration of having at least 80% of our shipment volumes covered by market with anti littering program in place for cigarette and for over 1,000,000 cumulative smoke free device to be refreshed or repaired. Moreover, during September, more than 10,000 stakeholders from more than 60 markets I am proud of our ESG performance, which continue to be recognized worldwide.

Speaker 2

Our 2021 low carbon transition plan and our business transformation strategy were recently nominated for sustainability prizes. And our Chief Sustainability Officer, Jennifer Motless, Was nominated for CSO of the Year at the World Sustainability Awards. Moving now to perhaps most impactful news of today. We are delighted to announce that we will soon have full control of IQOS, The world's leading smoke free product in the United States, the world's largest smoke free market. As previously communicated, Following the ITC decision last year prohibiting the import of IQOS into the U.

Speaker 2

S, we have been in discussion with Altria to find the best path forward. PMI's priority has always been to find a solution that best positions IQOS to realize its Full potential in the U. S. As quickly as possible. I am excited to report that we have now reached an outcome that achieved this goal.

Speaker 2

Let me start by briefly summarizing the key terms of the agreement. From April 30, 2024, TMI will have full control over the commercialization of IQOS in the U. S, allowing us to distribute and sell the product and critically and engaged directly with adult tobacco users. As part of the agreement, we will pay a total cash Consideration of around $2,700,000,000 to Altria. We believe this agreement represents excellent As with the previous agreement potentially stretching to 2029, this solution provides certainty by avoiding what could have been the protracted and uncertain legal process that could have severely impacted the development of IQOS.

Speaker 2

It provides a clear near term path to commercializing at scale in the U. S. With the unencumbered backing of PMI's full strategic and financial commitment to the product success. IQOS is the world's leading smoke free product with remarkable and rapid growth achieved across a wide range of international markets. From a standing start in 20 IQOS is already a $9,000,000,000 annual net revenue business, having created the attractive ethanol bond category and driving its growth.

Speaker 2

The U. S. Is the world's biggest accessible nicotine market by retail value. The estimated retail value of its growing smoke free market is already around 60% of all international markets combined, excluding China. We have spoken before about our plan to bring a leading portfolio to the U.

Speaker 2

S, and we expect IQOS to be at the very core of our U. S. Move free future, just as it already is elsewhere. The U. S.

Speaker 2

Opportunity for IQOS is particularly encouraging given the clear demand from American adult smokers for credible Smoke free alternative to cigarettes. Moreover, current smoke free products have had limited success in fully switching As a smoker away from cigarettes. In the U. S, there are ample opportunity to build adult smoker awareness and understanding our smoke free product offers, something that is particularly true for IQOS given our MLTP authorization. We are ready to invest behind IQOS to bring it to market at scale across the U.

Speaker 2

S, starting with Full scale launches in key cities and regions with a plan to progress rapidly to national penetration. IQOS remains the only in a label smoke free nicotine product to have received a modified risk tobacco product authorization from the U. S. We know from our experience in over 65 markets worldwide that IQOS Appeal to adult smokers who have tried the product is strong as demonstrated by high full switching rate. We have a strong commitment to build awareness and invest behind the category to drive product trial among American smokers.

Speaker 2

The true potential for IQOS in the U. S. Is substantial, as illustrated by the double digit national shares Achieved in just a few years across a number of Asian, European and other markets, All with varying demographic profiles and other smoker test preferences. We believe a volume share of 10% of cigarettes and HTUs by 2,030 is very achievable with potential to go much further. Importantly, the return on investment for IQOS in the highly profitable U.

Speaker 2

S. Tobacco market is compelling. We estimate the total U. S. Industry profit pool at over $20,000,000,000 and with average unit margin on U.

Speaker 2

S. Cigarettes more than 3 times greater than for the PMI average. The payback over the next few years on the consideration paid to Altria looks Very attractive. As we do not have a legacy cigarette business in the U. S, the opportunity is purely incremental.

Speaker 2

This also reflects a current excise tax system with no differentiation for Ita's Tobacco Products versus cigarette at the federal level and differential on a limited basis in only a handful of states, thus presenting a clear additional opportunity over time. We are already advanced in our plan for IQOS in the U. S. As we prepare for domestic manufacturing and for important regulatory submissions, including for IQOS Illumina, where we plan to file a PMTA in H2 2023. As mentioned previously, we target the first half of next year for the resumption of IQOS domestic supply, which will be available to Atria under our current arrangement until PMI assumes Our proposed combination with Swedish Match We provide certain U.

Speaker 2

S. Sales and distribution capability. However, in the case of failure, we have a clear path forward for IQOS and the rest of our smoke free portfolio. Indeed, the most critical part of the IQOS commercial model In addition, the U. S.

Speaker 2

Has an established distribution and retail landscape with a clear route to market. We, therefore, also have concrete plan to proceed autonomously In building fully controlled and managed U. S. Sales and distribution capabilities over the next 18 months, leading up to April 2024 in order to ensure a successful IQOS rollout and the introduction of other Indeed, we believe today's agreement is fundamental to unlock the U. S.

Speaker 2

As we have shared previously, we expect the heated tobacco category to remain the largest and fastest growing in dollar terms internationally. While the e vapor and to a lesser extent nicotine pouch category has paved the way for smoke free product in the U. S, We know that heated tobacco comes closest to replicating the experience that smokers enjoy with higher conversion and very low unintended use. Conclude today's presentation. Our business delivered strong Q3 and year to date performance despite some challenging headwinds, and we expect to deliver another excellent year of double digit adjusted diluted EPS growth on a pro form a on a currency neutral basis.

Speaker 2

Most impressive was the continued excellent IQOS performance with strong shipment volume and IMS growth, reflecting broad based momentum in the region, Japan and Emerging Markets. We remain excited by the promising results of IQOSILUMA, Our rich pipeline of smoke free innovation and plans for further launches of both Illumina and Zebra in the Q4 and in 2023. We continue to accelerate investments in our commercial program, digital engine and R and D for long term growth as well as behind a number of growth opportunities across category and geography. The return from such investments remain compelling as demonstrated by the exceptional top and bottom line growth delivered over recent years. In addition to growth in smoke free product, our combustible business continued to perform well with organic net revenue growth and essentially stable pro form a shipment volume.

Speaker 2

Despite accelerated pricing in the current inflationary environment, Temporary margin pressure from inflation and supply chain inefficiency is likely to continue in the coming quarters. Importantly, our underlying growth fundamentals remain strong, and we look forward with confidence. We have secured our near term access to the substantial U. S. Opportunity for IQOS, also forming the backbone for introducing our broader smoke free portfolio.

Speaker 2

We are now advancing on our plan to launch at scale with or without Swedish Match. And finally, We have increased the dividend every year as a public company to the ups and downs of economic and currency cycles. We continue to be steadfastly committed to returning cash to shareholders as we advance toward our ambition to become predominantly smoke free by 2,005. Thank you. And before we start the question and answer session, please note that we are not able to comment on our offer for Swedish Match beyond what has been announced.

Speaker 2

All materials related to the offer can be found on the website smokefreeoffer.com. And Jacek and I, we are now more than happy to answer your questions.

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 to a minimum of 2 questions each. 1 hour. Thank you.

Operator

Our first question will come from Chris Growe with Stifel. Your line is now open.

Speaker 3

Hi, good morning.

Speaker 2

Hi, Chris.

Speaker 3

Hi. I wanted to ask first if I could in relation to the operating margin. And I think it was up, if I have my numbers right, about a little over 100 basis points, if I exclude foreign exchange and acquisitions year to date. And I just want to get a sense when you look at the operating margin now, your expectation being down a little bit for the year. Does that incorporate a weaker 4th quarter operating margin and I guess to understand what's behind that if I have my numbers correct here?

Speaker 2

No, I don't think so, Chris. We are organically before ForEx down for the 1st 9 months With a number of impact that we described due to the situation, of course, of strong disruption on the supply chain coming from the war in Ukraine and the situation in Russia. We have, of course, some element of cost attached to the development of IQOSILUMA and that is, Of course, playing. We have a lot of airfreight that is impacting the margin. So you have a number of temporary elements that have been with us since almost the beginning of the year and that drove the operating margin down.

Speaker 2

I think that it will take a little bit of time for those to be removed, But we also have seen for the first time on something that is going to obviously stay with us, which is the inflation. We are seeing And inflation level for the time being around mid single digit. It could strengthen further because when we look at The number of inflation in many countries is above these mid single digit numbers. As we've been saying, we are entering into the renewal of a number of contracts That protected us to some extent on the way we are buying energy and the number of components. So that means that this part of Inflation is going to stay.

Speaker 2

But in Q4, actually, with a more positive mix and some maybe one off having a lower impact, We are expecting rather a better situation on margin evolution versus the first time one. So that's the opposite. We expect a Q4 that should be In terms of margin evolution, better than the 3rd line moves.

Speaker 3

Okay. Thank you. And then just a second question would be In relation to, you took your volume estimate up for the year, which is very encouraging. You had a very strong performance year to date. There's been a lot of concerns about Trade down activity, the concerns of consumers being able to having discretionary spending in particular in Europe and As we move forward as energy costs continue to remain so high, are you seeing any signs of that, any trade down activity or anything you could share that would help us get a better feeling

Speaker 4

Hi, Chris, it's Jacek. Not really. If you look at Down trading type of a pressure, we still don't see really an acceleration of the trends, right? So obviously, we The Indonesia, Philippines under pressure, but it's not much really changed versus what we have seen before. One could argue that in some geographies that inflation has a bit of a lagging Sort of evolution, but nothing today.

Speaker 4

And you could see also from the shares of Marlboro, right, We look pretty strong on the premium propositions, Okay. Despite the fact that we're taking the pricing and there will be pricing more pricing to come.

Speaker 3

Thank you for that. I appreciate it.

Speaker 4

Thank you.

Operator

Thank you. Our next Question will come from Pamela Kaufman with Morgan Stanley. Your line is now open.

Speaker 5

Good morning. Hi, Pam. Hi. So the U. S.

Speaker 5

Is clearly a large growth and profit opportunity for IQOS and it helps that you don't have an existing combustibles business here. How would your commercialization strategy in the U. S. Change if you came into the U. S.

Speaker 5

Through Swedish Match or independently? And how should investors think about the required level of Meant to commercialize IQOS in the U. S. And the impact to your growth algorithm.

Speaker 4

Yes. Hi, Paula. So I mean, what stands behind the success of IQOS is really the front end consumer interface, That's the commercialization aspect, which makes is one of the key element of IQOS success, which we measure as the Higher Zindendra, 3 rate of conversion, I. E. Adoption of IQOS and a full switching from cigarettes.

Speaker 4

Swedish Match doesn't have it, Right. So Swedish Match is the component of the sales force, which is essentially inter execution, but IQOS success hinges On that business to consumer component. So in both scenario, obviously, that's the investment which In front of us, but vis a vis a great market size and the profitability pool. So Swedish Match adds the component of the sales force, which is the in store execution. Obviously, it would be nice To have them, but this is not something which is unique in a sense that you cannot make it Organically, for example, okay?

Speaker 4

All other options can be at the table as well. The uniqueness of an IQOS is again, Engine commercial activations, if you follow us closer, we have spent enormous effort Behind the consumer journey and automating, digitalizing all touch points with The consumers and that's the value which we will be bringing. We'll have to invest, but the know how is on our side.

Speaker 5

Thank you. And then I have a question about the 90% threshold for the Swedish Match deal, which appears difficult to achieve in most circumstances. Would you consider lowering the threshold in the event that Your shareholders tender and what would be the challenges in operating the asset with a lower ownership stake?

Speaker 4

Well, we have asked for some understanding and not getting the questions from the Swedish Match deal. Like the fact of it is SEK116 And the 90% acceptance level, okay? And this is where we see the value of Swedish Match, the maximum of the value of the Swedish Match Today, and I will not comment beyond this whole thing. I think it is a fair market price, fair valuation of the company for the both group of the shareholders, BNI shareholders, Swedish Match shareholders, both long term and short term, and we will not comment beyond this one.

Speaker 5

Understood. Thank you.

Speaker 4

Thank you, Fang. Thank you.

Operator

Thank you. Our next question will come from Gaurav Yane with Barclays, your line is now open.

Speaker 6

Hi, good morning.

Speaker 2

Good morning, Gaurav.

Speaker 6

Hi. So a couple of questions from me. So first is on the entire plan around IQOS Commercialization in the U. S. And let's assume you are doing it standalone.

Speaker 6

So you will have to hire and I'm looking at some of your Competitors which have a 10% share in the U. S. Like Imperial, so they have a few 1,000 employees. So if you have to hire a few 1,000 employees and then you incur marketing investments. So should we model in like a few $100,000,000 of losses in the 1st few years

Speaker 2

before you scale up IQOS to

Speaker 6

a big enough volume where it starts generating incremental EBIT. Much like you had when you commercialize IQOS around the world, I remember like between 2015 and 2017, you had like a few like $700,000,000 or $1,000,000,000 kind of loss that you had identified at that time. So is that something similar we should do As you commercialize U. S?

Speaker 4

Yes. I mean, look, the directionally, you're right. I mean, obviously, Building the infrastructure, everything from a scratch requires several 100, thousands of employees. Now in the scheme of the 30,000 employees, which PMI has. No, it's not the first time that we're building an organization from scratch.

Speaker 4

And you're absolutely right that the initial years, couple of years will be on the loss As frankly speaking, we had vehicles in every country into which we enter. And if you're Following us closely, you know that we have achieved on markets The faster path to the breakeven that we had in a year 1 or 2 of the of our smoke free journey versus what we're achieving today. So it's a Ton of learnings. It's a tremendous learning and capability in organization, as I call the internal know how and the systems, etcetera, We don't have to reinvent the game. So we know pretty well the blueprint, a lot of things have been attested, etcetera.

Speaker 4

So U. S. Market will Enjoy your leverage, that sort of the things. So we'll come somewhere next year, we'll come with the more The ability of how we see the spending and the path, I think in the release, we have said that the most logical Based on our experience and the success on international, our most logical milestone near term, so let's Say 2030, 10 share points of the market, which if we see where we are in other places And what we achieved 6 years after, I. E.

Speaker 4

To date versus now I add the 6 years plusminus to the current 30%, 10%, I think we will execute accordingly. We have and Emmanuel in his remarks make it very clear, we'll Fully stand behind, including monetary and the human resources to deliver the success It's well overdue success of IQOS in the U. S.

Speaker 6

Sure. And a follow-up So now on the BAT litigation at ITC, which they won, the patent dispute. So look, so that prevents you from importing IQOS devices, Which is why you are now setting up the domestic manufacturing facilities. But can't that use those patent wins because clearly they have established they have some So I'm trying to understand how do you frame this entire patent litigation, even around your domestic ICOS manufacturing

Speaker 2

Well, Gaurav, on that one, we have To clarify, one thing is the ITC process where indeed there was a decision from ITC. But otherwise, on the Federal secret, I would say for the time being, there is rather success on our side. 1 of the Finally, of patents that have been claimed by BAT on their case with the ITC was actually Recognize as not valid in front of a U. S. Court.

Speaker 2

So I don't think that you can draw a parallel between what happened in the ITC And what is happening on the federal level in the U. S. And we believe That the domestic manufacturing is giving us a clear path and the capacity to reenter the U. S. Market.

Speaker 6

Okay. And if I could just ask one follow-up on what you just said. The IQOS Luma device, does it bypass all these patents which are under dispute.

Speaker 4

The case which we have with ITC case with Started by BAT is with regards to the IQOS 3.0.

Speaker 2

Sure. Thank

Operator

Thank you. Our next question will come from Bonnie Herzog with Goldman Sachs. Your line is now open.

Speaker 7

All right. Thank you. Hi, everyone. Hi, my first question is on your guidance. Your Q3 came in better than expected and you took Your full year currency neutral revenue guidance, but I guess I'm trying to reconcile this with your lower guidance on IQOS.

Speaker 7

I guess this implies you now expect Stronger results in your combustible business and possibly greater device sales. So could you walk through this for us, especially on device sales expectations in the second half possibly ramping and if there's a risk of retail inventory building that could potentially impact results next year.

Speaker 2

Yes, Benin. So no, There is nothing to do with the device in the guidance. You're right. We have slightly been moving the bracket for the HTU's volume, not massively, we're 90% to 92% and we're not 80% and we're now 89% to 91%. There are still parts of the bracket that is the same.

Speaker 2

Clearly, we see some compensation at the level of a very robust Combustible business, I think I've been flagging that in detail in the presentation. And that is giving us this Visibility on higher growth in volume than what we're anticipating so far, and we are raising the guidance to plus 2 to plus 3. We have been raising the guidance for revenue as well with the low end of the bracket that has been raised to plus 6.5%. And then we have the same adjusted EPS, notably because we see costs that are probably potentially a bit higher than what we anticipated a few weeks ago. So that is giving us the same bracket for adjusted EPS.

Speaker 2

But in a nutshell, that is how the guidance is evolving.

Speaker 7

Okay. Thanks for that. And then just my second question, I sorry, I have a follow-up question about the agreement you reached with Altria maybe asked a little differently. I guess I'm trying to get a sense of how you got comfortable with the $2,700,000,000 payment to Altria, which is quite a large lump sum of money. This is to get your exclusive rights to IQOS back in the U.

Speaker 7

S. So how confident are you That you're going to be able to reach this 10 share in the U. S. Market by 2,030, especially since it does feel Like the ramp will now likely be slower if you have to go it alone or even with Swedish Match. And then finally, as it relates to this, how do you think about not being able to use the Marlboro brand name in the U.

Speaker 7

S. Now?

Speaker 4

Yes. So with regards to the confidence, Bonnie, is that, look, this confidence beyond or behind IQOS is Growing every year, every quarter. I mean, now you'll see the results on the international markets. And we have the markets When we slower with markets, when we faster, but the potential for IQOS, the heat not burn is there, okay? If we look at the U.

Speaker 4

S, I don't think I don't couldn't cannot find the reasons why in the U. S. We cannot Replicate to come close to the success of international and the 10%, if you like the first double digit number, which we are I think we're focused on that. We will be also working to bring faster IQOS ILUMAC to And our international success has been built on IQOS 2.4 plus. So the U.

Speaker 4

S. Is Starting history, the journey with IQOS, the much better moment from a product perspective of our capability perspective, Understanding this entire category that we've been in our international markets. So this is where the confidence is coming from. And the second question is regards to the Marlboro. IQOSPERA in Japan is now By X factor, bigger than the HeatSticks Marlboro.

Speaker 4

And this was the last The market which we still have been using Albro trademark on our did not burn consumables. And as you know, at the very beginning, 6 or so years ago in a few markets, I recall it was Switzerland and Italy, we started with Marlboro and very early in the journey, We have almost overnight rebranded that thing and we dropped the Marlboro from the brand, from the And I actually believe that we have a Marlboro International and this is a great brand, but on cigarettes. And I have no doubt today that we are on the path that we can make IQOS As iconic brand on a global basis as in the past we have made Marlboro. So I don't see this as any impediment or bottleneck of our in our strategy in the U. S.

Speaker 7

Okay. Thank you.

Speaker 2

Thank you.

Operator

Thank you. Our next question will come from Priya Auri Gupta With Barclays, your line is now open.

Speaker 8

Hey, thank you so much for taking the question. First, I just had a quick administrative question. What is the U. S. Dollar equivalent, for the revised Swedish Match offer?

Speaker 8

Should we just use the current exchange rate or would there be any adjustment for any hedging that might have previously been put in place? And then I have another follow-up.

Speaker 2

I'm not sure to understand your question, Per. I mean, the offer is in Swedish kron, so we'll pay it in Swedish kron. Now What we've been reporting is the fact that the price increase that we are offering today Correspond to the impact of the currency fluctuation since the day of the announcement in May between the dollar and the Swedish kroner, Noting that a significant portion of the cash flow generated by Swedish Match is in dollar, but That's it. So I'm not sure if I understand your question.

Speaker 8

It was just whether so When you announced the transaction, the dollar amount would have been $16,000,000,000 and you're still sort of close to that just given the FX move, but was there any incremental hedging that was put in place.

Speaker 2

We can make your calculation. We can provide you with the number of shares of Swedish Match and you can make the calculation. So in dollar term, I think the amount is slightly lower. But again, please take into account the fact that Englishman is not 100% generating cash flow in dollar, okay. So you cannot just take the dollar amount at 100%, Thank

Speaker 8

you. That's helpful. And then as we think about sort of the 10% share that you've Getting to by 2,030 in the U. S. Market, how much of that includes contribution from Illumina?

Speaker 8

I guess as You put the PMTA or submit the PMTA in the latter half of next year, what sort of a timeline are you assuming around that getting to market and getting nationalized.

Speaker 4

Well, I mean, we're planning to file for PMT with VELUMA To FDA next year. So as we've seen recently, the Factoring in the timing of outcome of dealing with FDA is a little bit of a challenge, but There will be Luma obviously in this 10%. I won't give you the number now how much of the 10% is in Jigoni Luma, but let's take it again differently. We have a few markets, very successful, but still very few markets when Illumina plays the role today in our portfolio. And if you look, for example, for the European Union almost entirely, the success of the year 6 years In a commercialization of IQOS is built on the IQOS 2.4, 2.4 plus and F3, 3.1.

Speaker 4

So these are the products which We have relatively clear path to go in the U. S. So there will be Luma, but it's too early now Obviously, for us, it's Elumo offers benefits even further Then the blade technology, but on the blade technology, this is where we are today, 6 years in PMI. So I think we don't have to solve that equation today.

Speaker 8

Okay. That's very helpful. And then just Final question for me. I think as you discussed the inflationary pressure ramping from some of the contracts renewals that you're going Right now on the input side, how should we think about that headwind? Is it fair to think of that mid single digit rising to the high single digits.

Speaker 8

And then in terms of cadence, is it fair to assume sort of the greatest effect of that being on the first half of calendar twenty twenty three and then sort of moderating into the back half as you start to lap some of that. Thank you.

Speaker 2

Look, on the inflationary pressure, of course, very difficult to give a kind of definitive answer because this is A very fluid situation and with significant evolution. Today, if we assume that At a certain point in time, the inflation we are facing will be in line with inflation that is seen in many countries. Yes, that would probably mean that The mid single digit could go to high single digit. It can be a bit more complex than that because, of course, It depends on which kind of element of inflation we're exposed to, That could be, in some areas, a revolution for next year. Frankly, too early to say and also too early to say When is going to be the climax of that?

Speaker 2

Is it going to be at the end of this year in term of cost increasing? Are we going to see more inflation through 2023. I think it's too early to say. Of course, for the I mean, We'll monitor the situation, but I would say energy price is the energy price, if you see what I mean. There is not much we can do.

Speaker 2

We still need To buy energy, the answer for us is, of course, to react with price increase. And I think you have seen in our Q3 It is depending on what's going to be the environment and whatever it is to mitigate the impact of What we're going to see on inflationary pressure with price increase.

Speaker 8

Great. Thank you so much.

Speaker 2

Thank you.

Operator

Thank you. This does conclude today's Q and A portion. I would now like to turn the program back over

Speaker 4

So thank you very much for your attention. We're very happy that we Spending time with you, especially in this very important moment for us that our key strategy focus Strategic focus over the last good few months, if not longer, is how to find a much more clear unpredictable path to the U. S. Has been achieved with the achieving the deal with Altria and regaining the

Speaker 1

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

Operator

Thank you, ladies and gentlemen. This concludes today's event. You may now disconnect.

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