PHILIP MORRIS INTERNATIONAL (PM) Q3 2022 Earnings Call Transcript

PHILIP MORRIS INTERNATIONAL  ( ?????? : PM) Q3 2022 earnings call dated Oct. 20, 2022

Corporate Participants:

James Bushnell — Vice President, Investor Relations & Financial Communications

Emmanuel Babeau — Chief Financial Officer

Jacek Olczak — Chief Executive Officer

Analysts:

Christopher Growe — Stifel Institutional — Analyst

Pamela Kaufman — Morgan Stanley — Analyst

Gaurav Jain — Barclays — Analyst

Bonnie Herzog — Goldman Sachs — Analyst

Priya Ohri-Gupta — Barclays — Analyst

Presentation:

Operator

Good day, and welcome to the Philip Morris International Third Quarter 2022 Earnings Conference Call. Today’s call is scheduled to last about one hour, including remarks by Philip Morris International management and the question-and-answer session. (Operator Instructions)

I will now turn the call over to Mr. James Bushnell, Vice President of Investor Relations and Financial Communications. Please go ahead.

James Bushnell — Vice President, Investor Relations & Financial Communications

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2022 third quarter 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 US GAAP measures and additional smoke-free volume and net revenue data are 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 reflect currency-neutral adjusted results, excluding acquisitions and disposals. Figures and comparisons presented on a pro forma basis entirely exclude PMI’s operations in Russia and Ukraine. As mentioned previously, starting in the second quarter of 2022 and on a comparative basis, PMI excludes amortization and impairment of acquired intangibles from its adjusted results.

Today’s remarks contain forward-looking statements and projections of future results. I direct your attention to the forward-looking and cautionary statements disclosure in today’s presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements.

I’m joined today by Jacek Olczak, Chief Executive Officer and Emmanuel Babeau, Chief Financial Officer. Jacek will join us for the question-and-answer session. Over to you, Emmanuel.

Emmanuel Babeau — Chief Financial Officer

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 remove the potential of a protracted legal process to regain the US 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 US 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 US 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 US unit economics 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’s cash flows, which are in US 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, strengthens 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 margins in line with expectations, this resulted in total Q3 adjusted diluted EPS of $1.53, close to our all-time high — quarterly high despite notable currency headwinds.

IQOS’s excellent performance continued with 22% growth in pro forma HTU shipment volumes, a testament to the continued strengthening of our heat-not-burn portfolio and broad-based growth across key regions. IQOS ILUMA continues 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 now 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 topline growth and ongoing cost efficiencies 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 revenues 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, let’s turn to the pro forma full year outlook. Given the continued growth of IQOS and robust trends in combustibles, we are revising our topline forecasts upwards to plus 2% to plus 3% growth in total shipment volumes, and plus 6.5% to plus 8% growth in organic net revenues.

While our topline 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. 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 topline momentum is strong and we continue to forecast pro forma adjusted diluted EPS growth of plus 10% to plus 12% for 2022. This translates 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, 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 levels where possible to minimize any impact on consumer availability, however these factors are a constraint on our shipments 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 cash flow which benefitted 2021 at the expense of 2022 and by a further $0.5 billion of working capital improvements. However, our 2022 forecast demonstrates underlying growth against this exceptional year.

I would also like to highlight that US dollar strength has a positive impact on our net debt, given that more than 60% of our financing is in euros, 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 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 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 represents an impressive performance from the world’s leading cigarette brand. Our leadership in combustibles 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 combustibles and the continued growth of IQOS positions 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 contributions 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 two-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 30, 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 2.0 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 volume 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 brands 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 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 developments 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 market. 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 aspirations of having at least 80% of our shipment volumes covered by markets with anti-littering programs in place for cigarettes 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 US, we have been in discussions 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 US 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 US, 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 US, 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 US 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 US and we expect IQOS to be at the very core of our US smoke-free future, just as it already is elsewhere.

The US 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 US, 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 US, 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 US Food and Drug Administration. We know from our experience in over 65 markets worldwide that IQOS’s 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. The true potential for IQOS in the US 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 US tobacco market is compelling. We estimate the total US industry profit pool at over $20 billion and with average unit margins on US 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 US, the opportunity is purely incremental. This also reflects a current excise tax system with no differentiation for heated tobacco products versus cigarettes at the federal level and differentials 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 US 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 US sales and distribution capabilities. 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’s commercial model center on converting adult smokers rather than distribution. In addition, the US 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 US 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 US 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 US, 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 investment 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 US opportunity for IQOS, also forming the backbone for introducing our broader smoke-free portfolio. We are now advancing on our plans 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.

Questions and Answers:

Operator

Thank you. We will now conduct the question-and-answer portion of the conference. (Operator Instructions) Thank you. Our first question will come from Chris Growe with Stifel. Your line is now open.

Christopher Growe — Stifel Institutional — Analyst

Hi, good morning.

Emmanuel Babeau — Chief Financial Officer

Hi, Chris.

Christopher Growe — Stifel Institutional — Analyst

Good morning. 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 — over 100 basis points, if I exclude foreign exchange and acquisitions year-to-date. And I just wanted 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 fourth quarter operating margin? And I guess to understand what’s behind that if I have my numbers correct here?

Emmanuel Babeau — Chief Financial Officer

No. I don’t think so, Chris. We are organically, before ForEx, down for the first nine months. With a (Technical Difficulty) impact that we described due to the situation, of course, of a strong disruption in the supply chain coming from the war in Ukraine and the situation in Russia. We have, of course, some element of costs attached to the development of IQOS ILUMA and that is, of course, playing. We have a lot of air freight 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.

And I think that it will take a little bit of time for those to be removed, but we also have seen for the first nine months something that is going to obviously stay with us, which is the Inflation. We are seeing an inflation level for the time-being around mid single digit and it could strengthen further, because when we look at the number of inflation in many countries were still above this mid single digit numbers.

As we’ve been saying, we are entering into the renewal of a number of contract that protected us to some extent on the way we are buying energy and a number of components, so that means that this part of inflation is going to stay. But, in Q4, actually with the more positive mix and some maybe one-off, as in lower impact, we are expecting rather a better sort of situation on margin evolution versus the first nine months. So that’s the opposite. We expect a Q4 that should be in terms of margin evolution better than the first nine months.

Christopher Growe — Stifel Institutional — Analyst

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 and a very strong performance year-to-date, there has been a lot of concerns about trade down activity, the concerns of consumers having discretionary spending in — particular in Europe and Chile as we move forward as energy cost continue to remain so high. Are you seeing any signs of that, any trade down activity, anything you could share that would help us get a better feeling for the performance of some of your premium brands? Thank you.

Jacek Olczak — Chief Executive Officer

Hi, Chris. It’s Jacek. Naturally, if you look at downtrading type of a pressure, we still don’t see really an acceleration of the tracks, right? So obviously, we see the Indonesia and Philippines under pressure, but it’s not much really changed versus what we have seen before. One could argue that in some geographies, the inflation has a bit of lagging (inaudible) but nothing today. And you can see also from the shares of Marlboro, right we will look pretty strong on the premium propositions, okay, despite the fact that we taking good pricing and there will be in our pricing more pricing to come.

Christopher Growe — Stifel Institutional — Analyst

Thank you for that. I appreciate it.

Emmanuel Babeau — Chief Financial Officer

Thank you.

Jacek Olczak — Chief Executive Officer

Thank you.

Operator

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

Pamela Kaufman — Morgan Stanley — Analyst

Good morning.

Jacek Olczak — Chief Executive Officer

Hi, Pam.

Pamela Kaufman — Morgan Stanley — Analyst

Hi. So the US 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 US change if you came into the US through Swedish Match or independently? And how should investors think about the required level of investment to commercialize IQOS in the US and the impact to your growth algorithm?

Jacek Olczak — Chief Executive Officer

Yeah. Hi, Pamela. So –I mean what stands behind the success of IQOS is really the front-end consumer interface, right? That’s the commercialization aspect, which makes — is of the key element of IQOS’ success which we measure as the highest in the industry rate of conversion or adoption of IQOS and efforts switching from cigarettes. Swedish Match doesn’t have, right? So Swedish Match is the component of the sales force, which is essentially (inaudible) but

IQOS’ success hinges on that business-to-consumer component. So in above scenario, obviously, that’s the investment which is front of us but these are the a great — the market size and the profitability pull.

So Swedish Match adds the component of a sales force which is in-store execution. Obviously would be it’s nice-to-have them but this is not something which is unique in a sense that — but generally, you cannot make it or pay net organically, for example, while other options can be at the table as well

The uniqueness of IQOS is again the commercial engine, commercial activations. If you follow us closer with our spend and enormous effort in — behind the consumer enjoy and automating digitalizing those touch points with the consumers. And that’s the value which we will be bringing. We will have to invest but the know-how is another site. [ph]

Pamela Kaufman — Morgan Stanley — Analyst

All right. 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 fewer shareholders tender? And what would be the challenges in operating the asset with a lower ownership stake?

Jacek Olczak — Chief Executive Officer

While we have asked for you know some understanding, we’re not getting the question from the Swedish Match deal like the fact of life it is a 116 inside [ph] and the 90% acceptance level, okay? And this is where we see the value of Swedish Match — the maximum of the value to 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 above growth of the shareholders, PMI shareholders, Swedish Match shareholders, both long-term and short-term. And we will not comment beyond this.

Pamela Kaufman — Morgan Stanley — Analyst

Understood. Thank you.

Emmanuel Babeau — Chief Financial Officer

Thank you, Pam.

Jacek Olczak — Chief Executive Officer

Thank you.

Operator

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

Gaurav Jain — Barclays — Analyst

Hi. Good morning.

Emmanuel Babeau — Chief Financial Officer

Good morning, Gaurav.

Gaurav Jain — Barclays — Analyst

Hi. Sir, a couple of questions from me. So first is on the entire plan around IQOS commercialization in the US and let’s assume you are doing it stand-alone. So you will have to hire and I’m looking at some of your competitors, which have a 10% share and the US like imperial so they have a few thousand employees. So if you have to hire a few thousand employees and then you incur marketing investments, so should we model in like a few hundred million dollar of losses in the first few years before you scale up IQOS to a big enough volume where it starts generating incremental EBIT, much like you had when you commercialized IQOS around the world, I remember like between ’15 and ’17 you had like a few like $700 million or $1 billion kind of loss that you had identified at that time. So is that something similar we should do as you commercialize US?

Emmanuel Babeau — Chief Financial Officer

Yeah. I mean, look, directionally you’re right. I mean obviously building the infrastructure, looking from a scratch requires several hundred or thousands of employees now in a scheme of the 30,000 employees which PMI has. Now it’s not the first time that we’re building another organization from scratch. And you’re absolutely right that the initial years — couple of years will be on the loss as frankly speaking, we had with vehicles in every country into which we enter. And if you following us closely, you know that we have achieved on markets, the faster path to the breakeven that we had in the year one out of two of our smoke-free journey versus what we achieving today.

So it’s a ton of learning. It’s tremendous learning and capability in organization, I call internal know-how and the systems, et cetera, which we don’t have to reinvent the game. So we know pretty well the blueprint, a lot of things have been tested, et cetera. So US market will enjoy your leverage that’s sort of the thing.

So when we will come, you know, summer next year, we’ll come with the more visibility and probably see the spending and the past. I think in the release, we have said that the most logical based on our experience and the success on international and most logical milestone near-term so let’s say 20%, 30% (inaudible) point of the market which if we see where we are in other places and what we achieve six years after year-to-date versus now, I have six years plus-minus to the current 20% 30%, 10% I think we’ll exit accordingly. We have and Emmanuel in his remarks made it very clear. We fully stand behind including monetary and the human resources to deliver the success of IQOS in the US.

Gaurav Jain — Barclays — Analyst

Sure. And a follow-up question on the bad 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 (inaudible) use those patent trends because clearly they have established, they have some strengthened their patents and go to a domestic US court and also get injunctions against you’re selling off IQOS devices in the domestic market. So I’m trying to understand how do you frame this entire pattern litigation even around your domestic IQOS manufacturing and commercialization sort of strategy.

Jacek Olczak — Chief Executive Officer

Well, Gaurav, on that one, we have to clarify one thing in the ITC process where indeed there was a decision from ITC. But otherwise, on the federal (inaudible) I would say for the time being there is rather a success on our side. And one of the — finally our patents have been claimed by BAT. On the case with the ITC was actually recognize as much value in front of a US court.

So I don’t think that you can draw parallels between what happened in ITC and what is happening on the federal level in the US. And we believe that the domestic manufacturing is giving us a clear pass and the capacity to re-enter the US market.

Gaurav Jain — Barclays — Analyst

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

Jacek Olczak — Chief Executive Officer

The case which we have with that ITC case with (inaudible) started by BAT is with regards to the IQOS ILUMA 3.0.

Gaurav Jain — Barclays — Analyst

Sure. Thank you so much

Jacek Olczak — Chief Executive Officer

(Multiple Speakers) in a completely different part.

Gaurav Jain — Barclays — Analyst

Thank you.

Jacek Olczak — Chief Executive Officer

Thank you.

Operator

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

Bonnie Herzog — Goldman Sachs — Analyst

All right. Thank you. Hi, everyone.

Jacek Olczak — Chief Executive Officer

Hi, Bonnie.

Bonnie Herzog — Goldman Sachs — Analyst

Hi. My first question is on your guidance. Your Q3 came in better than expected and you took up your full year currency-neutral revenue guidance, but I guess I’m trying to reconcile this with your lower guidance on IQOS. 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?

Emmanuel Babeau — Chief Financial Officer

Yes, Bonnie. 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, 90% to 92%, and we are not 89% to 91%. So they are still part of the bracket that is the same. 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 are anticipating so far and we are raising the guidance to plus 2% to 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. But in a nutshell, that is how the guidance is evolving.

Bonnie Herzog — Goldman Sachs — Analyst

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 $2.7 billion payment to Altria, which is quite a large lump sum of money. This to get your exclusive rights to IQOS back in the US. So how confident are you that you’re going to be able to reach this 10% share in the US market by 2030, 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 US now?

Jacek Olczak — Chief Executive Officer

Yeah. So with regards to the confidence, Bonnie, is that, look, this confidence beyond the IQOS is growing every year, every quarter. I mean, you see the results on the international markets and we have a market when we slower, we have markets when we faster. But the potential for IQOS, the heat-not-burn is there. So if we look at the US, I don’t think — I cannot find the reasons whey in the US, 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 obtaining after six years in any other geographies and taking into considerations that US is starting with IQOS free that we will be also working to bring faster the IQOS ILUMA to US. And our international success has been built on IQOS 2.4, 2.4 plus. So the US is starting the journey with IQOS with much better momentum from a product perspective, our capability perspective, understanding this entire category that we’ve been in our international markets. So this is what the confidence is coming from.

And the second question with regards the Marlboro, IQOS Tera in Japan is now by X factor bigger than the HeatSticks Marlboro. And this was the last market, which we still been using a Marlboro trademark of our heat-not-burn consumables. And as you know, at the very beginning, six or so years ago in a few markets, if I recall, it was Switzerland and Italy, we started with Marlboro and very early in the journey, we have almost overnight, we branded the thing and we dropped the Marlboro from the brand, from the proposition. 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 would have made Marlboro. So I don’t see this as any impediment or bottomneck of — in our strategy in the US.

Bonnie Herzog — Goldman Sachs — Analyst

Okay, thank you.

Jacek Olczak — Chief Executive Officer

Thank you.

Operator

Thank you. Our next question will come from Priya Ohri-Gupta with Barclays. Your line is now open.

Priya Ohri-Gupta — Barclays — Analyst

Hey, thank you so much for taking the question. First, I just had a quick administrative question. What is the US dollar equivalent for the revised Swedish Match offer? Should we just use the current exchange rate or would there be an adjustment for any hedging that might have previously been put in place? And then I have another follow-up.

Emmanuel Babeau — Chief Financial Officer

I’m not sure to understand your question, Priya. I mean, the offer is in Swedish Krona and we’ll pay it in Swedish Krona. 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 Krona, noting that a significant portion of the cash flow generated by Swedish Match is in dollar. That’s it. So I’m not sure to understand your question.

Priya Ohri-Gupta — Barclays — Analyst

It was just whether that — so when you announced the transaction, the dollar amount would have been $16 billion. And you are still sort of close to that just given the FX move, but was there any incremental hedging that was put in place?

Emmanuel Babeau — Chief Financial Officer

We can make our calculation. We can provide you with a 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 Swedish Match is not 100% generating cash flow in dollars. So you cannot just take the dollar amount at 100%, to be very clear.

Priya Ohri-Gupta — Barclays — Analyst

Okay. That’s helpful. And then as we think about sort of the 10% share that you’ve discussed getting to by 2030 in the US market, how much of that includes contribution from ILUMA, I guess, as you put PMTA or submit the PMTA in the latter half next year, what sort of timeline are you assuming around that getting to market and getting nationalized?

Jacek Olczak — Chief Executive Officer

Well, I mean, we are planning to file for PMTA with ILUMA 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 ILUMA, obviously, in this 10%. I won’t give you the number now how much of the 10% is hinging on ILUMA, but let’s take it again differently. We have a few markets very successful, but still very few markets when ILUMA played the role today in our portfolio.

And if you look, for example, for the European Union, almost entirely, the success of the six years in commercialization of IQOS is built on the IQOS 2.4, 2.4 plus and 3, 3.1. So these are the products which we have a relatively clear path to grow in the US. So there will be ILUMA, but it’s too early now to say how much of the 10% will be there. Obviously, for us, it’s — ILUMA offers benefits even further than the Blade technology. But on the Blade technology, this is where we are today, six years in PMI. So I think we don’t have to solve that equation today.

Priya Ohri-Gupta — Barclays — Analyst

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 contract renewals that you are going through right now on the input side. How should we think about that headwind? Is it fair to think of that sort of mid single digit rising to the high single digits. 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 ’23 and then sort of moderating into the back half as you start to lap some of that. Thank you.

Emmanuel Babeau — Chief Financial Officer

Look, on — in 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 has seen in many countries — yeah, that will 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, but that could be in some areas and evolution for next year. Frankly, too early to say and also too early to say when is going to be the climax of that. 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, we — I mean, we will monitor the situation, but I would say energy prices — I mean, there is not much we can do. 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 an acceleration of our price increase, we are getting at almost 5%, which is showing the capacity depending on what’s going to be in this environment and whatever it is to mitigate the impact of what we’re going to see and an inflationary pressure with price increase.

Priya Ohri-Gupta — Barclays — Analyst

Great. Thank you so much.

Emmanuel Babeau — Chief Financial Officer

Thank you.

Operator

Thank you. This does conclude today’s Q&A portion. I would now like to turn the program back over to management for any additional or closing remarks.

Jacek Olczak — Chief Executive Officer

So, thank you very much for your attention. We’re very happy that we spend this hour 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, has helped to find a much more clear and predictable path to the US has been achieved through achieving the deal with Altria and regaining the full control of IQOS, so we’re very happy that you spend this hour with us today. Thank you.

Emmanuel Babeau — Chief Financial Officer

Thank you. Till too soon. 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.