Chief Financial Officer at Philip Morris International
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, the world's largest smoke-free market from April 30, 2024. Indeed, today's agreement with Altria removes the potential of a protracted legal process to regain the U.S. rights to IQOS which Altria previously held, subject to performance milestones until 2029. We have ambitious plans for the full-scale launch and rapid expansion of IQOS in the U.S. market as soon as we take over and 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. smoke-free industry, and it will be followed by the other products in our smoke-free portfolio.
In this context, Swedish Match offers an immediate position in the oral segment, and mutually beneficial synergies at sales force 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. 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 SEK116. Our updated offer retain 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. 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 shareholders, 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 full ownership.
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. 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 quarterly high despite notable currency headwinds. IQOS excellent performance continued, with plus 22% growth in pro-forma HTU shipment volume, a testament to the continued strengthening of our heat-not-burn portfolio and broad-based growth across key regions. IQOS ILUMA continue to drive growth in its launch markets.
In combustibles, we delivered robust performance with Q3 organic pro-forma net revenue growth exceeding plus 4%, driven by accelerated pricing of almost plus 5%. Cigarette shipment volumes were essentially stable and category share grew, supported by Marlboro, showcasing the resilience of the brand despite current economic conditions.
Turning to the headline numbers. Our Q3 volumes grew by plus 2.3% on a pro-forma basis, and by plus 0.6% in total, including Russia and Ukraine. Pro-forma net revenues grew organically by plus 6.9% and by plus 6.7% for total PMI. Our total organic net revenue per unit grew by plus 4.5% on a pro-forma basis and by plus 6.1% in total despite lower device revenues. This reflects the increasing weight of IQOS in our sales mix and a step-up in combustible pricing.
Our Q3 adjusted operating income margin declined organically by 100 basis points on a pro-forma basis and by 90 basis points in total, consistent with our expectations. As previously communicated, this reflects the recovery in device volumes, the investments in launching ILUMA, 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 enabled us to outperform our previous currency-neutral guidance to deliver adjusted diluted pro-forma EPS of $1.33, including unfavorable currency of $0.23, representing plus 8.3% currency-neutral growth. Including Russia and Ukraine, we delivered adjusted diluted EPS of $1.53.
Our strong third quarter, combined with a robust H1, supported an excellent delivery for the year-to-date. I would highlight our strong pro-forma volume growth of plus 3.4% and organic net revenue growth of plus 7.7%, again reflecting continued strong IQOS performance, pricing and the recovery of the combustible business in many markets against a pandemic-affected comparison. Smoke-free net revenue made up around 30% of our year-to-date pro-forma total, putting us on-track to reach our ambition of over 50% by 2025.
Our year-to-date operating income margin contracted organically by 110 basis points on a pro-forma basis, driven by the factors mentioned previously. We remain on-track to deliver cost savings of $2 billion over 2021-2023. $1.5 billion of gross savings have already been delivered, including over $200 million in Q3. This allows us to reinvest in the business and mitigate increasing inflationary pressures. Year-to-date currency-neutral adjusted diluted EPS grew by plus 9.7% to $4.11 on a pro-forma basis and by plus 8.8% in total to $4.59; an excellent performance.
Now lets turn to the pro-forma full year outlook. Given the continued growth of IQOS and robust trends in combustibles, 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 remain 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. Inflation in our cost of goods remained mid-single digit in the third 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 ILUMA in Japan and other launch markets has an initial negative margin impact, given the higher weight of the consumables and increased cost of both the device and consumables in the first 12 to 18 months of activation. As mentioned previously, the combination of strong demand, global supply chain disruption and the impact of cancelling induction HTU 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 million impact from a significant increase in the use of air freight.
As a result, while we continue to expect a rebound in our Q4 adjusted OI margin, partly reflecting higher commercial investments in the prior year, we are now forecasting less expansion than previously expected, with pro-forma 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-forma adjusted diluted EPS growth of plus 10% to plus 12% for 2022. This translate into a pro-forma 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 estimated exchange rate impact. For total PMI, which assumes a full year contribution from Russia and Ukraine, we expect adjusted diluted EPS of almost $6.00, including an estimated $0.80 unfavorable currency impact.
Lastly, given the continued success of ILUMA and the cancellation of TEREA production in Russia I just referenced, we are working to further accelerate our production of induction consumables. As we convert and transition capacity from blade to induction, we incur certain inefficiencies and limits on the availability of ILUMA HTUs. 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 billion to 91 billion units for the year. Importantly, this is a short-term supply dynamic. Consumer offtake 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.
The cash generation capacity of our business remains exceptional, as shown through the challenges of recent years. Our balance sheet and cash flow remain strong. We delivered operating cash flow of $7.7 billion year-to-date, representing growth of plus 6.5% on a currency-neutral basis. Today, we reconfirm our forecast of around $10.5 billion in operating cash flow for the full-year, despite an estimated currency headwind of around $1.3 billion. This means we expect to deliver an excellent $22.5 billion over 2021 and 2022. Cash flow was flattered somewhat in 2021 by $0.5 billion from one-off impacts and the timing factors of certain cashflows which benefitted 2021 at the expense of 2022, and by a further $0.5 billion of working capital improvement. 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 $1.5 billion reduction in our net debt since December 2021, which is now below 1.6 times adjusted EBITDA on a 12-month rolling basis. This delivery highlight 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-forma shipment volume increased by plus 2.3% for Q3 and plus 3.4% year-to-date, putting us comfortably on-track to deliver total volume growth for the second consecutive year on both a pro-forma and total PMI basis. Pro-forma HTU shipment volumes grew by plus 21.9% for the third quarter and plus 15.8% year-to-date. 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 IMS growth in Q4.
Focusing now on combustibles. Our portfolio delivered robust pro-forma organic net revenue growth of plus 4.1% in Q3 and essentially stable pro-forma shipment volume. Our pro-forma pricing accelerated to plus 4.9% in Q3 as we progressively adjust to the inflationary environment. This reflects notable contributions from Australia, Germany and the Philippines, and a positive quarterly variance from Indonesia for the first time since Q4 2019. We now expect full-year pricing to be around 4%.
Our pro-forma 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 a premium position in a challenging consumer environment, this represent an impressive performance from the world's leading cigarette brand. Our leadership in combustibles helps to maximize switching to smoke-free products and we continue to target a stable category share over time, despite the impact of IQOS cannibalization.
The positive combination of stable share in combustibles and the continued growth of IQOS position us to deliver total market share growth over time. We captured plus 0.5 points of pro-forma 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 third quarter. This remarkable achievement is supported by the increasing deployment of a 2-tier HTU portfolio, providing adult smokers with an expanding range of innovative and high-quality alternatives to cigarettes. PMI HTUs again strengthened their position as the second largest nicotine brand in markets where IQOS is present, with a sequential share gain in Q3 of plus 0.2 points to a record 7.7% share excluding Russia and Ukraine.
Focusing now on IQOS performance. We estimate there were approximately 19.5 million IQOS users as of September 30th, excluding Russia and Ukraine. This reflects growth of around plus 0.5 million users in Q3 and plus 2.7 million year-to-date. As shown on the right-hand side of this slide, the third quarter of each year typically experiences slower pro-forma user growth due to seasonal factors. The growth of plus 0.5 million 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 restrictions on retail locations and mobility. Importantly, we expect a strong acceleration in user growth in the fourth quarter of 2022.
In the EU region, smoke-free net revenues comprised almost 40% of regional net revenues 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 third quarter HTU share increased by plus 2 points compared to Q3 last year to reach 7.3% of total cigarette and HTU industry volume. I would also highlight the plus 0.2 point sequential increase, which is a notably strong performance given the usual seasonality of the combustible market. Most importantly, adjusted IMS volumes continued to grow sequentially and reached a record high of 8.7 billion units on a four 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.
With regard to regulation in the EU, we are encouraged by the increasing number of countries adopting multi-year fiscal frameworks with clear differentiation of smoke-free products, such as the recent legislation in Romania. We expect the proposal on the EU Tobacco Excise Directive to be published by year-end and hope for a similar approach. As a reminder, the Tobacco Excise Directive will require unanimous support for approval by all 27 EU member states.
Now let's focus on the performance of ILUMA in the EU region. ILUMA continues to drive user acquisition, the switching of existing users 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 TEREA now the clear majority of HTU sales in both markets. We also launched ILUMA 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 brands 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 plus 0.7 point sequential increase this quarter a notable achievement. IMS again, grew sequentially to reach a record high of 8.3 billion units on a four-quarter moving average. This was driven by the impressive performance of IQOS ILUMA and the continued growth in key cities such as Tokyo. The heat-not-burn category now represents over one-third of total tobacco in Japan, with IQOS increasingly driving the year's growth.
IQOS ILUMA 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 TEREA HTUs continued to grow strongly in Q3 and strengthened their position as both the second largest nicotine brand and largest RRP brand in Japan, reaching an exit offtake 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. We exited Q3 with over 25% HTU offtake share, a record high, and continue to see a long runway of growth in Japan over the coming quarters.
In addition to strong IQOS gains 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-forma HTU growth in Q3. Given the large size of these markets, the premium position of the existing IQOS portfolio and the relatively early stage of commercialization, this represents outstanding progress. Strong growth in IMS volumes continued, and the pro-forma 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 reflect success across many markets, with notable progress in Lebanon, where Q3 offtake share in Beirut increased by plus 7 points to 18%, and Egypt, where offtake share in Cairo is approaching 6%. Further key city 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 products. Smoke-free 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 activities 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 markets. It is a simple, convenient and affordable proposition, which can cater to local taste preferences without compromising on the reduced risk profile of the product. We are planning pilot city launches in Colombia and the Philippines during the fourth quarter, as we further expand our portfolio of smoke-free products to serve different consumer needs.
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 products is a key pillar of our sustainability strategy, which is reflected in our sustainability index and forms part of our executive compensation scheme. Our approach to reduce waste related to cigarettes, RRP consumables, devices and packaging is covered in a 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 markets with anti-littering program in place for cigarette and for over 1 million cumulative smoke-free devices to be refreshed or repaired.
Moreover, during September, more than 10,000 stakeholders from more than 60 markets joined clean-up initiatives around the world. I am proud of our ESG performance which continues to be recognized worldwide. Our 2021 Low-Carbon Transition Plan and our Business Transformation Strategy were recently nominated for sustainability prizes, and our Chief Sustainability Officer, Jennifer Motles, was nominated for CSO of the Year at the World Sustainability Awards.
Moving now to perhaps the 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.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 achieves this goal.
Let me start by briefly summarizing the key terms of the agreement. From April 30, 2024, PMI will have full control over the commercialization of IQOS in the U.S., allowing us to distribute and sell the product and critically engage directly with adult tobacco users. As part of the agreement, we will pay a total cash consideration of around $2.7 billion to Altria. We believe this agreement represents excellent value to our shareholders, as with the previous agreement potentially stretching to 2029, this solution provides certainty by avoiding what could have been a protracted and uncertain legal process that would have severely held back the development of IQOS. 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's 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 2015, IQOS is already a $9 billion annual net revenue business, having created the attractive heat-not-burn category and driving its growth. 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 plans to bring a leading portfolio to the U.S. and we expect IQOS to be at the very core of our U.S. smoke-free future, just as it already is elsewhere.
The U.S. opportunity for IQOS is particularly encouraging given the clear demand from American adult smokers for credible smoke-free alternatives to cigarettes. Moreover, current smoke-free products have had limited success in fully switching adult smokers away from cigarettes. In the U.S. there are ample opportunities to build adult smoker awareness and understanding of smoke-free product offers, something that is particularly true for IQOS given our MRTP authorization. We are ready to invest behind IQOS to bring it to market at scale across the U.S., starting with full-scale launches in key cities and regions, with a plan to progress rapidly to national penetration. IQOS remains the only inhalable smoke-free nicotine product to have received a Modified Risk Tobacco Product Authorization from the U.S. Food and Drug Administration.
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 rates. We have a strong commitment to build awareness and invest behind the category to drive product trial among American smokers. 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 adult smoker taste preferences. We believe a volume share of 10% of cigarettes and HTUs by 2030 is very achievable with potential to go much further. Importantly, the return on investment for IQOS in the highly profitable U.S. tobacco market is compelling. We estimate the total U.S. industry profit pool at over $20 billion, and with average unit margins on U.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. This also reflect a current excise tax system with no differentiation for heated tobacco products versus cigarettes 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 plans for IQOS in the U.S., as we prepare for domestic manufacturing and for important regulatory submissions, including for IQOS ILUMA, 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 Altria under our current arrangement up until PMI assumes full commercial responsibility in April 2024.
Our proposed combination with Swedish Match would provide certain U.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 parts of the IQOS commercial model center on converting adult smokers, rather than distribution. In addition, the U.S. has an established distribution and retail landscape, with a clear route-to-market. We therefore also have concrete plans 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 roll-out and the introduction of other smoke-free products should our Swedish Match offer fail.
Indeed, we believe today's agreement is fundamental to unlock the U.S. smoke-free market. 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 categories have paved the way for smoke-free products 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.
To conclude today's presentation, our business delivered strong third-quarter 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-forma currency-neutral basis. Most impressive was the continued excellent IQOS performance, with strong shipment volume and IMS growth reflecting broad-based momentum in the EU region, Japan and emerging markets. We remain excited by the promising results of IQOS ILUMA, our rich pipeline of smoke-free innovation and plans for further launches of both ILUMA and VEEBA in the fourth quarter and in 2023.
We continue to accelerate investments in our commercial programs, digital engine and R&D for long-term growth, as well as behind a number of growth opportunities across categories and geographies. The return from such investments remains compelling, as demonstrated by the exceptional top and bottom-line growth delivered over recent years. In addition to growth in smoke-free products, our combustible business continues to perform well, with organic net revenue growth and essentially stable pro-forma shipment volumes. Despite accelerated pricing in the current inflationary environment, temporary margin pressure from inflation and supply chain inefficiencies 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. 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, through the ups and downs of economic and currency cycles. We continue to be steadfastly committed to returning cash to shareholders as we advance towards our ambition to become predominantly smoke-free by 2025.
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. All materials related to the offer can be found on the website smokefree-offer.com. And Jacek and I, we are now more than happy to answer your questions.