Earnings Call Transcript
Philip Morris International Inc. (PM)
Earnings Call Transcript - PM Q4 2021
Operator, Operator
Good day, and welcome to the Philip Morris International Fourth Quarter 2021 Year-End 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. Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community. I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.
Nick Rolli, Vice President of Investor Relations and Financial Communications
Welcome, and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2021 fourth-quarter and full-year results. You may access the release on www.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.S. GAAP measures and additional heated tobacco unit market share data are at the end of today's webcast slides, which are posted on our website. 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 underlying results. Following the acquisitions of Fertin Pharma, OtiTopic and Vectura Group, PMI added the other category in the third quarter of 2021. Business operations for the other category are evaluated separately from the geographical operating segments. 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. Please also note the additional forward-looking and cautionary statements related to COVID-19. It's now my pleasure to introduce Jacek Olczak, our Chief Executive Officer; and Emmanuel Babeau, our Chief Financial Officer. Over to you, Jacek.
Jacek Olczak, CEO
Thank you, Nick, and welcome, everyone. I hope you are all well. Our business delivered an excellent performance in 2021, reaching record net revenues, adjusted diluted EPS and cash flow with growth in overall volumes, high single-digit organic net revenue growth and strong double-digit adjusted EPS growth. This illustrates the sustainable nature of our growth based on new products and innovation, as demonstrated by the continued strength of IQOS, which delivered 31% full-year organic growth in RRP net revenues. Smoke-free products surpassed 30% of total net revenues in Q4, as we progress towards our ambition of becoming a predominantly smoke-free company by 2025. We were especially pleased by the reacceleration of our business in Q4 to deliver a better-than-expected result. This reacceleration was visible in organic net revenues, IQOS user growth, heated tobacco unit market shares across developed and emerging markets, innovation in devices and consumables, and commercial investments and combustible share. IQOS user growth recovered in Q4 to reach an estimated 21.2 million total users, despite ongoing tightness in device supplies in the second half of the year. Full year heated tobacco unit shipment volumes grew 25% to reach 95 billion units, with broad-based growth for both our volumes and the category across key geographies, with an especially positive rebound in the EU. The growth outlook for IQOS remains very positive, with outstanding initial results from IQOS ILUMA in Japan and Switzerland, the only two launches so far, and growing traction for IQOS VEEV in early launch markets. In combustibles, we essentially reached our goal of stable category share in the fourth quarter despite the impact of IQOS cannibalization. During the year, we laid the foundations for our long-term growth ambitions beyond nicotine in Wellness and Healthcare, including the milestone acquisitions of Fertin and Vectura, which provide essential capabilities for future product development. And last, bolstered by strong operating cash flow, we continued to prioritize returns to shareholders through a 4.2% increase in the dividend and ongoing share repurchases. Turning to the headline numbers. Our full-year adjusted net revenues grew organically by 7.6% or 10.3% in dollar terms, including positive currency. This reflects the continued underlying strength of IQOS and the ongoing recovery of the combustible business in many markets compared to the pandemic-affected prior year. Our net revenue per unit grew 5.3% organically driven by the increasing proportion of IQOS in our sales mix and pricing. Combustible pricing was in line with our expectations at 2.7% or around 4%, excluding Indonesia. Our adjusted operating income margin increased by 200 basis points on an organic basis, in line with our expectations, with continued positive effects from the increasing size and profitability of IQOS, pricing and productivity savings. Through the first half expansion, although strong H1 expansion was tempered in the second half by the expected initial higher unit cost of IQOS ILUMA, geographic and category expansion investment and the Q4 resumption of consumer programs in a number of markets. Our resulting adjusted diluted EPS of $6.08 represents 17.6% growth in dollar terms and 15.3% currency-neutral growth, which is well above our prior guidance as IQOS user growth, the launch of ILUMA and total industry volumes exceeded our expectations. Finally, we generated operating cash flow of $12 billion, reflecting excellent underlying cash conversion in addition to strong Q4 business results and certain timing factors. Looking at our Q4 performance, net revenues grew by 8.4% organically. This reflects the sequential improvement in IQOS user acquisition and the initial success of ILUMA in Japan and strong overall volumes, including a further recovery in combustibles. We delivered robust organic net revenue per unit growth of 4.1%, again reflecting our shift in business mix. We achieved this despite softer pricing on combustibles of 1.4% due to the previously flagged challenges and comparison effects in Germany and Australia. Our Q4 adjusted operating income margin declined by 10 basis points on an organic basis, primarily due to the same factors mentioned for the second half as accelerating business performance opened more opportunities for investment in future growth. Despite that, our currency-neutral adjusted diluted EPS again grew strongly by 11.9%, also reflecting a lower interest cost and effective tax rate. Turning now to 2022 guidance. After the temporary slowdown in IQOS user growth in the second half of 2021, the device supply situation is gradually improving. While the situation remains fluid, we now expect a more limited impact, allowing us to gradually return to prior rates of user progression over the coming quarters. With the remarkable success of ILUMA in its first market, a number of other innovations planned and promising growth for IQOS in low and middle-income markets, our 2022 growth fundamentals are strong, and we look forward to an exciting year. We note that the slower user growth in the second half of 2021, particularly in the third quarter, will have an estimated carryover effect on our growth this year of around 4 billion to 5 billion heated tobacco units. This is reflected in our 2022 expectations of 113 million to 118 billion H2 shipment volume. Given this continued growth, we expect our full-year H2 shipments to again be ahead of IMS volumes. We expect to deliver between 4% and 6% organic net revenue growth keeping us well on track to deliver our 2021-2023 compound annual growth rate target of more than 5%. This range prudently incorporates the continuing uncertainty on full device availability and the pace of the ongoing pandemic recovery. For Duty Free, we assume no meaningful pickup in Asian travel, but a continued gradual recovery in other geographies. We expect our adjusted operating income margin to expand between 50 and 150 basis points as the positive effects of our product transformation continues, despite the expectation of a moderately lower gross margin. This is essentially attributable to temporary ILUMA related factors such as the higher initial weight and cost of TEREA consumables and the cost of devices, which we expect to decrease over the 18 to 24 months post-launch as we have experienced with previous major innovations. We also account for higher logistic costs, where the tremendous uptake of ILUMA in Japan has led to increased use of air freight investments to grow capacity across our smoke-free platforms and inflation in certain supply chain elements. Operating income margin expansion and continued growth opportunities in wellness and healthcare R&D will again be supported by our ongoing efficiency programs. We remain on track to deliver around $2 billion in gross savings by 2023. Accordingly, we forecast currency-neutral adjusted diluted EPS growth of 8% to 11%. This translates into an adjusted diluted EPS range of $6.12 to $6.30, including an estimated unfavorable currency impact of around $0.45 at prevailing rates. This is primarily due to translation effects, and this currency impact reflects notably the appreciation of the euro, Japanese yen and Turkish lira versus the dollar. This guidance includes the impact of $785 million of share repurchases made in 2021, which were somewhat restricted by blackout periods. It does not reflect the impact of repurchases in 2022 as we continue to take an opportunistic approach within our target of between $5 billion to $7 billion over three years. Our guidance also reflects the impact of acquired businesses, which we expect to generate underlying operating income in line with our business plan, but with an operating loss of around $150 million or approximately 1% of adjusted diluted EPS, which we'll come back to explain later. As outlined in today's release, there are a number of other assumptions underpinning our outlook. We expect the total industry volume of cigarettes and heated tobacco units, excluding the U.S. and China, to decline between -1% and -2%. Given our leadership in smoke-free products, the structural growth of the category and its growing proportion in our business, we expect to gain share and target broadly stable total PMI shipment volumes within the range of -1% to +1%. We assume full-year combustible pricing of 3% to 4% with a softer first half and a stronger second half of the year. This is clearly above 2021 levels. The pricing environment is improving but still challenging in central markets with ongoing pandemic-related impacts. Our balance sheet is strong. We delivered excellent operating cash flow of $12 billion in 2021, reflecting robust underlying cash conversion in addition to favorable timing and one-off impacts of around $0.5 billion. With further strong organic profit growth expected in 2022, we expect to generate around $11 billion of operating cash flow, subject to year-end working capital requirements and after accounting for the reversal of timing benefits and using prevailing exchange rates. As a result, we raised our 2021 to 2023 operating cash flow target communicated at the February 2021 Investor Day from $35 billion to the range of $36 billion to $37 billion. We also expect full year capital expenditures of around $1 billion, reflecting increased capacity investments behind our smoke-free platforms, including ILUMA and enhancing our digital commercial engine in addition to certain projects which were delayed due to the pandemic. Lastly, looking specifically to the first quarter of 2022, we expect adjusted diluted EPS of $1.50 to $1.55, including $0.15 of unfavorable currency at prevailing rates. We expect robust organic top line growth and operating margin comparisons, which reflect above the very strong prior year quarter, which benefited from a high level of productivity savings and relatively low levels of investment and the Q1 of 2022 dynamics of commercial investments, ILUMA-related costs and increases in some inputs such as freight. Let me now hand over to Emmanuel, who will give you more details on our performance in 2021.
Emmanuel Babeau, CFO
Thank you, Jacek. Turning back to our 2021 results. Total shipment volumes increased by 4.2% in Q4 and by 2.2% for the year. This reflects continued strong broad-based growth from heated tobacco units of 25% or 18.9 billion units for the full year, comfortably exceeding the decline of 3.6 billion cigarettes. The 2.4% increase in our Q4 cigarette volumes reflects the continued sequential recovery of the total industry and of our category share, in addition to a 2.7 billion stick favorable inventory movement, which mainly reflects inventory reduction in the prior year quarter. Due to the remarkable performance of IQOS, heated tobacco units comprised almost 14% of our total shipment volume in the fourth quarter and 13.2% for the year, as compared to 11% in full year 2020, 8% in 2019 and 5% in 2018. Our sales mix is evolving rapidly, putting us on track to become a majority smoke-free company by 2025. Smoke-free net revenues made up over 30% of our adjusted total revenue in Q4 and 29% for the year as compared to 24% in 2020. In 10 markets, we have already surpassed 50%. IQOS devices accounted for over 6% of the $9.1 billion of 2021 RRP net revenues with a step up in H2, reflecting the IQOS ILUMA launch, outweighing the effect of the supply constraint on the IQOS versions. We delivered 7.6% organic growth in 2021 net revenues on shipment volume growth of 2.2%, reflecting the twin engines driving our top line. The first is pricing on combustibles and in certain markets on heated tobacco units. The second is the increasing mix of heated tobacco units in our business at higher net revenue per unit, which continues to deliver substantial growth and increasingly powerful driver as our transformation accelerates. Let's now turn to the driver of our 2021 margin expansion. Our gross margin increased by 190 basis points on an organic basis due to product mix, pricing and cost savings, while our adjusted marketing, administration and research costs were 10 basis points better as a percentage of adjusted net revenues. We generated over $800 million in gross cost savings in 2021 with around $550 million in manufacturing and supply chain productivity and more than $250 million in SG&A efficiency before inflation. This represents strong progress towards our target of around $2 billion for 2021-2023 and allows us to reinvest in top line growth while continuing to deliver robust margin progression. While operating income margin expansion was lower in H2, this reflects the positive dynamic of our business and the ability to return to normalized investment levels compared to the pandemic-affected prior year. ILUMA device and heated tobacco unit shipments commenced with higher initial unit cost, and we reaccelerated investments in our commercial program, digital engine and R&D as well as multiple growth opportunities across categories and geographies. We intend to continue investing in such opportunities in 2022, but with the benefit of scale, operating leverage and accelerated efficiencies, we continue to target organic SG&A increases below the rate of sales growth. Moving now to market share. Our share of the combustible category recovered and was essentially stable in Q4 on a year-over-year basis, as our portfolio initiatives bear fruit and pandemic-linked restrictions eased in many markets. 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. In terms of our overall share, ongoing gains for our IQOS portfolio create positive momentum going into this year, and we expect to resume overall share growth as well as achieve broadly stable total shipment volume. PMI heated tobacco units now have a 7.1% share in the markets where they are present, making them the third largest tobacco brand. This includes the number one position in five markets and the number two in a further six markets. Moving now to IQOS performance. We estimate there were approximately 21.2 million IQOS users as of December 31. The improved growth of 0.8 million in Q4 reflects our agile commercial model, which allowed us to rapidly adjust our consumer program and assortment. As demonstrated by the performance of ILUMA in Japan and Switzerland, the underlying momentum of the IQOS brand remains strong. While we don't yet have full visibility over the full year of 2022, as device shortages ease, we expect to gradually return to user growth at or above the prior run rate of around 1 million per quarter. We estimate that 72% of total users, or 15.3 million adult smokers, have switched to IQOS and stopped smoking, with the balance in various stages of conversion. In the EU region, fourth quarter heated tobacco unit share reached 6.4% of total cigarette and heated tobacco unit industry revenue, 1.4 points higher than Q4 last year. Underlying IMS growth trends remain excellent. This very good performance included strong growth across the region, with Italy reaching the milestone of 2 million users and a positive contribution from Germany and Poland. I also want to highlight Hungary, where our Q4 national heated tobacco unit share exceeded 20%, following Japan and Lithuania, reaching this important threshold. To give some further color on our progress in the EU region, this slide shows a selection of the latest key city offtake shares. While Vilnius continued to lead the way with a 37.5% share, the 20% level was also reached in Budapest, Rome and Athens. With strong progress across the region, we are especially pleased by Vienna, which almost doubled to 4%, the strong traction in London at almost 6% share, and an acceleration in Zurich with the introduction of IQOS ILUMA. We show further heated tobacco unit share data in the appendix to these slides. Share growth continued in Russia with our Q4 total units share up by 0.8 points to reach 8%. For both Russia and the overall region, sequential growth in adjusted IMS slowed in the last two quarters, partly reflecting the more acute device shortage and the lead on our commercial program. In addition, the region was affected by the halting of sales in Belarus, which impacted sequential IMS growth in Q4. In this context, as mentioned in last quarter, we have seen some increased discounted competitor offerings and disposable e-vapor products. We continue to see high interest in the category, and with a pipeline of exciting innovations planned, including the launch of ILUMA, we aim to resume strong growth this year. In Japan now, the adjusted total tobacco share for our heated tobacco unit brands increased by 1.7 points to a record 21.8% in Q4, with an offtake exit share approaching 23%, incorporating the pull-forward of consumer uptake into Q3 before the price increase. This performance reflects the strength of our portfolio and the launch of IQOS ILUMA, which I will come back to shortly. The overall heated tobacco category continues to grow, making up over 31% of the adjusted total Japanese tobacco market in Q4; with IQOS maintaining a high share of segment and capturing the majority of the category's 2021 growth. In addition to the strong progress in developed countries, we see very promising IQOS growth in low and middle-income markets. A prime example of this is Egypt, where offtake share in Cairo is approaching 4% within six months of launch, with other notable successes including Lebanon, Jordan, the Dominican Republic and the Philippines despite declining performance in Manila. This low and middle-income market's key city performance is especially encouraging as we achieved it despite the premium position of the current IQOS portfolio. We do intend to bring a new complementary range of heat-not-burn products tailored to emerging markets towards the end of this year, which I will come back to. With this potential in mind, we continue to drive the geographic expansion of our smoke-free products, as we aim to be in 100 markets by 2025. During the quarter, we launched IQOS in both Morocco and Tunisia. This takes the total number of markets where PMI smoke-free products are available for sale to 71, of which 30 are in low and middle-income markets. We plan to add more markets this year as we also broaden our product offering and price segmentation within existing geography. This includes the expansion of feel and feet, which are now available in over 20 markets across multiple regions and our expansion of e-vapor and nicotine pouches. Following the implementation of the ITC's importation ban, IQOS is not currently available in the U.S. We continue to work on contingency plans, including domestic manufacturing, and hope to be able to resume U.S. supply in the first half of 2023. It is important to remember that the ITC's decision on this patent is an outlier. We were encouraged by the U.S. patent office's recent invalidation of one of the two patents included in the ITC ruling, and we expect a decision on the second patent by April 2. However, these decisions are subject to an appeal process. BAT has been universally unsuccessful in asserting the same two patent families against IQOS in Europe. Separately, in December, a German court ruled that BAT's GLO HYPER dual-coil heat-not-burn device infringes our patents and that we are entitled among other things to an injunction against BAT's sales of the device. Moving now to IQOS ILUMA. We are delighted to report the outstanding success since its launch in Japan and Switzerland, with sales performance and consumer reaction exceeding our expectations. In Japan, the uptake of ILUMA devices and consumables among both existing IQOS users and legal adult smokers has been rapid, with more than 20% of the large user base switching since the August launch and over 20% of sales to legal age smokers due to IQOS. Moreover, the enhanced and consistently high-quality user experience, better reliability and no need for cleaning has led to significant observed increases in conversion rates, retention rates and Net Promoter Scores. This bodes well for volume growth, and indeed, premium-priced TEREA consumables have been the fastest-growing launch in the smoke-free category, reaching an offtake share in the three main convenience store chains of 8% within three months of national launch, driving the growth of the heat-not-burn category following the October tax-driven price increase. Early results in Switzerland have been even more remarkable with over one-third of sales to new users and TEREA making up over one-third of HD sales after only two months of commercialization. Our heated tobacco unit share growth has accelerated accordingly from 6% in September to 7.9% in December. These results are very encouraging for the wider rollout of ILUMA in the EU region and around the world, and we plan to roll out gradually to more markets this year, mostly in H2. While we continue to manage device supply constraints, the unprecedented growth in Japan also means we have had to accelerate both the supply of TEREA consumables using airfreight and the conversion of our production line to support new market launches. With ILUMA, IQOS 3 DUO and LIL, we now have three heat-not-burn technologies under the IQOS umbrella to serve different consumer needs and segment the market. We have an exciting pipeline of innovation on devices and consumables across our technology at different price tiers. As I mentioned, we also plan to enhance our portfolio for future growth with the introduction of a new complementary technology towards the end of this year. This will be targeted at smokers in low and middle-income markets, catering to the consumer need for simple, high-quality, affordable devices and consumables and specific local taste preferences. In terms of heated tobacco units, after launching over 15 new ILUMA SKUs in Q4, we plan to continue expanding our portfolio across platforms, geography, and price points this year. We continue to commercialize IQOS VEEV with very promising results in the first group of markets where we started in our own channel with a limited range of test variants and nicotine levels. IQOS VEEV is a premium product, providing a superior experience, and the commercial framework of IQOS allows us to deploy efficiently and at scale through a bespoke route-to-market approach. As we start to expand distribution and the consumable offering, we observe signs of increased uptake and clear positive consumer feedback compared to competitive products. We see encouraging success in Italy and the Czech Republic, reaching double-digit offtake shares of close to 10 points, with rapid progress also visible in Croatia within three months of launch. After launching in Canada and Ukraine in the fourth quarter, we plan to add more markets in 2022 with timing subject to device availability. We also continued preparation to apply for a PMTA from the U.S. FDA and now prudently assume readiness for filing in early 2023, given further clarity on the required preparatory steps. An additional exciting midterm growth opportunity is in the nicotine pouch category, where we aim to become a leading player with the Shiro brand. Nicotine pouches provide a convenient smoke-free alternative for adult smokers and, while still early in many markets, we see Shiro playing an important role in our smoke-free portfolio over the coming years. Following the acquisition of AG Snus and Fertin Pharma, we have established a base of product development and manufacturing expertise. Although we are still learning about the promising category, our IQOS commercial infrastructure allows for a fast rollout, and we plan a number of launches over the coming quarters. The first major activity is the full re-launch of the revitalized Shiro portfolio in the Nordics this month from its more limited prior presence with full commercial activity and a broad portfolio of flavors and strength variants. Separately, following feedback from the 2021 consumer test of our Platform 2 carbon product, the design of our current technology has been discontinued. We are assessing an alternative design for this consumer segment. Turning now to our nascent business beyond nicotine, the 2021 acquisitions of Fertin, Vectura, and OtiTopic provide the base for building critical respiratory and overall product development capabilities alongside our existing expertise. This opens up opportunities to deliver the positive effects of existing wellness and healthcare molecules in a fast and effective manner. For the time being, our reported number in the other segment showed the existing acquired business, which delivered $101 million in net revenue in the fourth quarter and a marginal operating loss of $1 million. The underlying performance is in line with our expectations, with reported operating expenses reflecting the amortization of intangible, deal-related items and our planned investments. Around 39% of Q4 revenue was derived from Fertin's smoking cessation product and nicotine pouch operations. While we intend to continue the CDMO activities of the acquired companies, the most significant value to PMI is in our ability to develop and commercialize new products in the wellness and healthcare segment over time. We plan important R&D investments over the coming years to support our aim of delivering meaningful incremental revenue starting two to three years from now as we pursue our ambition of at least $1 billion of net revenue from wellness and healthcare products by 2025. As I mentioned earlier, we expect an operating loss of around $150 million in 2022, with revenue of around $250 million, including smoking cessation products. We recognize investor interest in our future product line in these new areas and plan to provide more color at our CAGNY conference presentation on February 23. Moving to sustainability and our ESG priorities, I'm happy to share that we recently completed a new sustainability feasibility assessment to update and recalibrate our priorities in accordance with our biggest impact on society, double materiality, and extensive stakeholder inputs. While addressing the health impact of our products remains our biggest focus, we also identified several topics that are emerging in importance or require an evolved approach. We will publish the results next week. It is increasingly important to align management incentives with sustainability materiality, performance, and impact. We will strengthen this link in 2022 with the new sustainability index and plan to provide more details in the near future. Our progress on sustainability continues to be recognized by leading external stakeholders with repeated inclusion in both the Dow Jones Sustainability Index North America and the Bloomberg Generic-Quality Index, and receiving CDP's AAA score for the second year running. We also published an agricultural labor practices report, marking 10 years of the program. Since its introduction, we have successfully eradicated systemic issues related to child labor, while improving the living condition of farmers and farm workers. It also outlined our ambitious targets such as having 100% of farmers supplying tobacco to PMI making a living income by 2025. On our most critical priority of product impact, the growing penetration of smoke-free products around the world is accelerating the end of cigarettes as legal age smokers reach for better alternatives. I am also pleased to report further recent positive regulatory developments. For example, as part of its beating cancer plan, the European Parliament's special committee recognized and featured harm reduction in its last report, for which the plenary vote will take place next week. In New Zealand, the government published its more action plan, expressly excluding smoke-free products from the proposed measures. Additionally, several countries, including Poland and Russia, have announced new multiyear excise tax plans with taxation of smoke-free products clearly differentiated from cigarettes, making 15 markets globally with such plans. There is a growing body of scientific and real-world evidence of the substantial reduction potential of smoke-free products compared to smoking. While challenges in some markets are expected, we continue to support regulatory and fiscal frameworks that recognize this critical harm reduction opportunity. I will now turn back to Jacek for some concluding remarks.
Jacek Olczak, CEO
Thank you, Emmanuel. Overall, we are very pleased to have delivered excellent growth last year in 2021 with a strong underlying momentum for IQOS as well as the record adjusted EPS, net revenues, and cash generation. The consistent quality and sustainability of our organic top and bottom-line delivery have been clearly demonstrated over the last two years, which I believe we all acknowledge with appreciation. With an improving outlook for device supply, although still a need for agility, the exceptional initial success of ILUMA and the number of innovations and growth initiatives, we look forward to 2022 with tremendous excitement. At the same time, we'll be building our development capabilities in wellness and healthcare for targeted investment to support the next driver of our long-term growth. Our balance sheet is strong, and we have increased cash returns to shareholders through a higher dividend and our share repurchase program, in line with our objective to deliver sustainable value and returns to investors as we continue our smoke-free transformation. In short, we continue to see a bright future for our business. Following a very strong 2021, we remain confident in our 2021 to 2023 growth targets and in our ambition to be predominantly smoke-free by net revenues in 2025. Thank you all for your attention. Emmanuel and I will be happy to answer your questions.
Operator, Operator
Thank you. We will now conduct the question-and-answer portion of the conference. Our first question will come from Bonnie Herzog with Goldman Sachs. Please go ahead.
Bonnie Herzog, Analyst
Hi, Jacek and Emmanuel. I hope you're both doing well. I have a question on your EPS guidance this year. It's quite a wide range at 8% to 11% on a currency-neutral basis. So I was hoping you could highlight some of the key assumptions or drivers that put you maybe at the low end of that range versus what needs to happen for you to get to the 11% growth? For instance, is 11% possible even if the chip shortage situation doesn't get resolved for the next few months?
Jacek Olczak, CEO
I think Emmanuel.
Emmanuel Babeau, CFO
I'm going to take this. So, obviously, and we've been trying in our preliminary remarks, we are still facing a number of uncertainties. COVID does not disappear even if things seem to be improving. We don't have full visibility on the IT shortage and on the supply chain globally. And that is obviously what is behind some certainly cautiousness on the guidance that we are giving on the top line. And then from there, we, of course, are driving a business that is seeing good momentum. We have the traditional driver of price increase. We're going to be very efficient on cost savings. You can see what we've been delivering in 2021, already more than $800 million of efficiency on our cost. We're going to continue in 2022. And I know that is going to drive the difference between the revenue growth and the adjusted EPS organic growth. One of the headwinds that we're going to face this year, which I think we should see as very positive because it's coming from the growth, and we are managing a very nice potential of growth is that we are investing for exciting opportunities. It starts, of course, with ILUMA in Japan, but globally, the launch of ILUMA will certainly have a big impact in Japan, where we know that when we launch a new product, this has some impact on the cost of goods because we are not at the same level in terms of efficiency on the supply chain. The productivity is not at its maximum, and we've been explaining that in our remarks. That is going to have some impact at the launch. We talked about air freight as well and that is to have an impact. We indicated what we see today is a moderate decrease of the gross margin rate. Without that, it would have been from what we see today, another year of growth of the gross margin rate. But that's really what is driving the guidance. So we have some uncertainty, but we are very excited about the potential for growth that we see with all this innovation that is coming up. We have the traditional drivers of efficiency that are going to help. We have some headwinds, which were planned because we are introducing innovations, and we need to invest to launch these innovations. And I should add in terms of innovation that we are also expanding in terms of geography; what we see in Egypt bodes extremely well for the potential in emerging countries, but we need to invest, of course, to build the capacity. We need to develop our commercial tools. We need to invest in the new platform, vaping and nicotine pouches. So what I think is great in this guidance and in our ambition for 2022 is that it's a year with a lot of investment for exciting growth, but we are still able to deliver strong dynamic top lines. We are able to deliver nice margin improvement, good organic growth at a good level. And as you have seen, we are hugely cash generative, and we do that at the same time while investing for the future.
Bonnie Herzog, Analyst
Okay. That's super helpful and honestly makes a lot of sense. So clearly, a lot of puts and takes, but you've got a lot of levers to pull. For my second question, I maybe wanted to switch gears a bit and just kind of ask a little bit about the situation in the U.S. and just maybe an update. It sounds like you expect to get back in the market next year with IQOS. So maybe love to hear a little more color on this. And will the build-out of the production in the U.S. be your financial responsibility? And then Altria mentioned some issues between you two in terms of the agreement you have in their fourth quarter press release. So just was hoping to better understand what that could mean. For instance, I guess, if Altria fails to meet the terms of the agreement, would you then pursue distribution of IQOS in the U.S. yourselves? And/or, I guess, find another distribution partner? Can you kind of walk through that for us? And then I'm thinking on tech of a potential solution for VEEV in the U.S., assuming it gets approved.
Jacek Olczak, CEO
Yes. So Bonnie, as we're working on the bringing the manufacturing capacity for IQOS to the U.S. That's our main mitigation plan or reaction plan to where we are today post the ITC event. As we said, we think that by the summer at the beginning of next year, we should be in a position to resume shipments in the U.S. As we and Altria are close, we have some disagreements regarding whether Altria has fulfilled certain milestones in the current contract, and we're currently in negotiations or discussions with Altria to resolve it. I believe in good faith we should find some solutions. I wouldn't know beyond speculating on what other options and how we would approach IQOS going forward in the U.S. I mean, our partnership remains important, and I think we should see some amicable solution between both partners. Now I have said it on a number of occasions; in the U.S. market is, as a few other markets, one in which we have a very negligible but strategically important presence. You've heard us in the past, and you know how we performed with IQOS across all essential geographies. I mean, it's really well below what I would expect at this stage or characterize the potential of IQOS. If I consider this, the fact that this is an inhalable FDA-authorized product, you don't really have competition and the size of the market, etc., I think it's fair to say that expectations were much beyond where we are today. But I will stop here, and I believe we will find a good resolution, which will, on one hand, enable American smokers to have access to that technology and also something which will be accretive to our partner's results there.
Operator, Operator
We'll take our next question from Chris Growe with Stifel. Please go ahead. Your line is open.
Chris Growe, Analyst
I wanted to ask about IQOS. There was a notable increase in the number of IQOS users in the fourth quarter. I'm curious if you believe reaching around 1 million users sequentially will not be possible until the second half of '22, or if supply will be adequate to see that level of user growth in the first half of '22. I'm trying to understand the availability of devices to gauge growth for '22.
Jacek Olczak, CEO
Yes. Look, the Q4, reacceleration of coming back to the previous user growth is highly encouraging. I just confirmed that IQOS had that ability of continued growth. Obviously, it's very much hinges on the fact that we have unrestricted availability of the devices. And remember IQOS today has had a heat-not-burn proposition, which we have today consist of a few versions of IQOS blade product. I should mention real product coming through the other partnership with TMG and IQOS ILUMA. And all of that also rather create a certain portfolio of proposition for various target consumers. We regained a little bit of flexibility in recomposing the full portfolio in Q4. Hence, in Europe, we've all seen the spectacular regain in the user acquisition. It is somewhat reflected in our 4% to 6% growth target and the heated tobacco unit target for this year that for how many months or for many weeks in a year, we think we can have unrestricted access to the full product portfolio of the devices very much. I believe that actual IQOS can fly higher if we're in the unrestricted mode, but some factors in the product have to be accounted for for next year; we should have a larger scenario, which is maybe on the moderate side, etc. If we didn't have all these constraints coming from a device as a couple of other things in the supply chain, I believe we would be looking at different numbers. But at this stage, it's difficult to start assigning that to something which we think we can deliver. I’m saying the IQOS has a higher potential growth rate, but when you really have to think about the moment when we can operate unconstrained. Needless to say that part of our growth is coming from the Asia region. Although the European Union was less than part of the one that you like, it seems like it's moving past COVID now, we're still not at the stage in Japan and a few other locations. So we also have to start factoring this in. But I'm very optimistic that we can deliver in 2022 and, frankly speaking, knowing how many headwinds we need to take on our test in 2022, I start looking honestly excited about 2023.
Emmanuel Babeau, CFO
Just to complement your question on, can we reach 1 million. I think we see rather a ramp-up today. It doesn't mean that we cannot reach 1 million in one of the quarters in H1, but it's true that we see a ramp-up and an acceleration as we go through the year.
Chris Growe, Analyst
I have a quick question regarding the U.S. related to Bonnie's inquiry. Is there a possibility that you could succeed in the patent office review, allowing you to resume importing the product before the first half of 2023? While you are preparing your supply chain in the U.S., could there be a chance that you win on the patents and are thus able to import the product again?
Jacek Olczak, CEO
The entire process certainly warrants a separate discussion regarding patent laws and the related procedures. Unfortunately, we have to navigate through this situation. If we succeed in invalidating some patents, the opposing party has the right to appeal, which significantly prolongs the overall timeline. It could take an additional couple of years before either party can claim complete success. Following that, we would need to engage with the ITC to implement the restrictions currently affecting us. I believe the quickest way to re-enter the U.S. market is by reactivating our domestic capabilities and supplying the market locally. In the future, we might be limited, which would allow the U.S. market to receive supplies from both domestic and international sources. However, I think our immediate opportunity lies in the approach we've outlined.
Operator, Operator
We'll take our next question from Pamela Kaufman with Morgan Stanley. Please go ahead. Your line is open.
Pamela Kaufman, Analyst
I have a question about your outlook for combustible pricing in 2022. Pricing in 2021 was below your historical rate of growth, given headwinds in Indonesia. But can you talk about your expectations for pricing and the pricing environment in 2022? And how you're prioritizing price realization versus market share in combustibles?
Jacek Olczak, CEO
Yes. So we're looking for, as we said, we're looking at the 3% to 4% pricing variance this year, which is better and stronger than last year. I think some Asian geographies have a variety of factors that are still presumably driving lower prices than we think we could have normally realized, comparing at least to the historical trends we have there. Indonesia, you're absolutely right, is on the negative side, although the tax increases that the industry has to pass on give some hope that we can return to that pricing is an important component of growth there. But we also have to take it from the perspective of the impact of recovery, the volumes, and presumably how much we can unwind in 2022 and how much we can build at a pace for 2023. It's going in the right direction, but a bit more is needed. The pricing environment is difficult to predict, but as we characterize it, it's improving across all our geographies. We have pretty good visibility at this stage. As you know, in some countries, the tax increases cannot be passed on to consumers in one step. You need to have some preparatory phase to take some pricing before and some pricing after, so it is heading in the right direction, especially when we take it in the context that every country, every market is under huge pressure on public finances due to the COVID situation.
Pamela Kaufman, Analyst
Right, thank you. My second question is on ILUMA uptake. And if you can provide some more color on how much of the new user growth in Japan has been driven by ILUMA for IQOS? And what observations you have around the user base and the interaction with prior versions of IQOS?
Jacek Olczak, CEO
Yes. If you remember from the very beginning, I was personally very excited about that innovation. I am so happy that it delivers on my expectations, and actually it is even exceeding my expectations. So I will continue if you allow me to present an enthusiastic voice. ILUMA does generate, obviously, new IQOS users; blade product users appreciate the benefit of ILUMA the first moment they have it in their hands and through their initial experiences. The response from consumers in Japan is phenomenal. Obviously, while ILUMA goes to existing users, we also already have the benefit of existing IQOS users switching to ILUMA because it provides uninterrupted consumption throughout the day. This has an impact on volumes. If I provide users with a device, which is much more convenient to use and is much more reliable, you will have a tendency to increase consumption compared to what you have with a blade product. So that's a very good thing. Second, is ILUMA, after all of these initial months, we observe a solid higher level of conversions. This is a very important component in the business model; having many devices will fully convert smokers and knowing how many will stay because it releases pressure on the margins. Third, about 20% of ILUMA sales are coming from individuals who have never used our products before. We also start seeing some return of users who had temporarily shifted from IQOS to competitive products. Therefore, in whatever aspect of performance of ILUMA we look at, it really delivers on every axis. The question is again, and I know that this might concern some, do we have availability of the devices? And can we continue supplying the market? So far, everything is going in the right direction.
Operator, Operator
We'll take our next question from Vivien Azer with Cowen. Please go ahead. Your line is open.
Vivien Azer, Analyst
My first question is on pricing. Certainly, encouraging to hear that your outlook for 2022 contemplates an improvement in pricing relative to last year. I was wondering, however, if you could just comment on how you're thinking about price gap management between your combustible cigarettes and your heated tobacco units, please?
Jacek Olczak, CEO
Essentially, in most or all markets, we maintain the same sort of positioning of IQOS today versus the cost of combustible reference points. As you know, most tax systems actually have that conversion mechanism baked in. So if there is a tax increase on combustibles, this proportionately triggers the increase on heated tobacco units, which translates to the consumer price gaps remaining essentially untouched. We will of course adapt depending on the market situation and our portfolio. For example, we did this very successfully in Russia and a few European markets. Overall, we aim to make our portfolio broad given pricing attractiveness for cigarette smokers to switch to heat-not-burn.
Vivien Azer, Analyst
Perfect. And my follow-up question pertains to the decision to discontinue Platform 2 TEEPS. Certainly, that product has been under evaluation for a number of years. I was just curious to hear the key takeaway from the consumer test. Is the problem that consumers are using a live heat source, and that's just creating a lot of confusion in terms of the reduced risk proposition? Was it product performance? Just any other color would be helpful.
Jacek Olczak, CEO
Actually, I think that, to put it simply, it was more on the user interface rather than anything else. I don't think that past the number of market tests conducted on the proposition, the feasibility of the concept as a better alternative to smoking is an issue. The problem pertains to the heat pipe. As you remember, the design of the product featured a cigarette-like appearance which required lighting. And this created questions around how to extinguish the product, especially when you're using it, and this impacted adoption rates. The decision to discontinue the product stemmed from consumer feedback indicating that the current design did not meet convenience and usability expectations. We plan to revisit this idea with an improved approach to design and technology in the future.
Operator, Operator
We'll take our next question from Gaurav Jain with Barclays. Please go ahead.
Gaurav Jain, Analyst
So I have a couple of questions. So first one is on your guidance. Your volume growth is -1:1. You are saying cigarette pricing will be three to four. And then category price mix in that slide that you have is plus three, assuming it is a three. So it should come to plus 5% to plus 8% on revenue growth for FY '22, but you are saying 4% to 6%. So that will imply that the category mix uplift will be less in FY '22 than was the case in FY '21. So can you just help us understand why that will be the case?
Jacek Olczak, CEO
I'm happy to elaborate, Gaurav. Certainly what we are expecting in 2022 is to have another favorable variance between volume growth and revenue growth. Indeed, we are guiding from -1% to +1% volume growth. Then the question is how much we are going to generate in terms of extra growth there is from pricing, where we're predicting 2% to 4%. Remember, we've done 2.7% in 2021. The low end is not massively above what we did last year. It's true that it could be better, and it's certainly something we are factoring in at the high end. There is also the impact on the growth of the IQOS business, where we expect positive mix developments. However, with the launch in many new economies and emerging countries, this could have an impact on the differential. Overall, we do expect a very strong differential again but not necessarily at the same level as the differential we achieved in 2021. Lastly, we see a temporary higher weight on the consumables for IQOS ILUMA. This is impacting revenue, and while I expect a strong differential again, we are acknowledging the factors leading to a more moderate outlook than prior years.
Gaurav Jain, Analyst
Okay. That's very helpful. And my second question is on the beyond nicotine segment where you will have $150 million of operating losses this year, and you also mentioned investing in it in future years so that you can hit the $1 billion revenue target. So does it mean that the losses we should expect to be higher in FY '23 than what they will be in FY '22? Or when could we expect that segment to break even?
Jacek Olczak, CEO
Well, I think there will be an investment for the next few years, not just a couple, but a few years, which we are willing to do. I think if you stay with us and wait until the CAGNY where we will provide more insight into what we have in our strategy regarding the beyond nicotine wellness and healthcare business, then we can give a clear overview of which products or programs we're willing to pursue, the size of the opportunity and the type of investment needed. I would say that the numbers we provided for 2022 in terms of investment reflect a ballpark for the investments we expect over the next couple of years.
Emmanuel Babeau, CFO
It's not a one-off. It could go a bit higher, but I don't expect an explosion here. I think you have a good calibration of the cutout that we're going to invest over a few years.
Operator, Operator
We'll take our next question from Jared Dinges with JPMorgan. Please go ahead.
Jared Dinges, Analyst
First, I want to touch a bit more on the nicotine pouches. How should we be thinking about the scale of that initial launch in the Nordics? And how should we think about the future market launches that you guys touched on a bit? Are you considering launching nicotine pouches in markets that don't have a nicotine pouch presence today, like in some of your emerging markets? And also, just looking at the potential in the U.S., would you consider a PMTA application there as well?
Jacek Olczak, CEO
Yes, I would leave the U.S. aside for a second. I think nicotine pouches can play a very important role as a smoking cessation tool. They have shown scalability in many markets. We initially are taking share in markets where there was some sales, albeit not very high. We begin where we have already established a presence and build on this. We've been able to successfully collect feedback from consumers to enhance the product. We also have some product pipeline behind the initial offering which we could accelerate significantly thanks to the acquisition of Fertin. Fertin allows us to utilize broader opportunities beyond just the pouches; they provide interesting technology for oral delivery. We will be thinking about pouches, but I believe the category of oral nicotine delivery could be a very attractive opportunity moving forward.
Jared Dinges, Analyst
Got it. So you would consider the U.S. PMTA application?
Jacek Olczak, CEO
I think I answered that question to Bonnie. The U.S. is an attractive market, and I believe it carries strategic importance to us. Ultimately, yes, but our focus today is somewhere else.
Jared Dinges, Analyst
Got it. And the second one, going back towards cigarettes and IQOS. Are you guys worried at all about potential impacts of price elasticity especially with lower income consumers given the inflationary environment and where you guys are positioned in most markets, where you're usually more at the premium end. So maybe you can give a comment on that?
Jacek Olczak, CEO
Yes. Price elasticity is always a concern, and we know that sometimes is elevated due to income pressures on the consumers. We are currently experiencing this in a few markets where consumers face income pressures, but I believe some of these pressures will ease as the COVID situation becomes a thing of the past. I don't think this is a systemic concern. It's interesting that if we evaluate the market, we see that we are taking pricing on cigarettes and Heat Sticks, and the market has a robust set of data showing that smoking alternatives tend to have better price elasticity due to the increased competition in the category. At this stage, it appears that alternatives have a better elasticity than traditional products. From a perspective of overall affordability, we've seen substantial success with IQOS in low and middle-income countries. However, to gain more significant inroads, we will need to offer a proposition targeting the lower price segment. We plan to test a new technology that will help us provide devices and consumables that meet affordability needs while maintaining quality.
Operator, Operator
And there are no further questions at this time. I will turn the call back over to the management team for any closing remarks.
Jacek Olczak, CEO
This was a call longer than expected, but we also delivered better-than-expected results last year. I think somehow we match it. Thank you very much for your attention. We invite you to our CAGNY presentation, where we will be positioned to provide more insights into some aspects like wellness and healthcare, and a broader view of these categories. We hope to convey how excited we are about the achievements in 2021 and remain positive despite the number of headwinds we faced. We still look forward to a highly successful and rewarding 2022 for both of us. Thank you for your attention and hope to see most of you, if not all, at our upcoming CAGNY presentation.
Emmanuel Babeau, CFO
Thank you all. See you soon.
Nick Rolli, Vice President of Investor Relations and Financial Communications
Thank you very much. If you have any follow-up questions, please contact the Investor Relations team, and just a reminder that the slides and scripts are available on the PMI website. Thank you very much. Have a great day.
Operator, Operator
Thank you. And this does conclude today's Philip Morris International fourth quarter 2021 year-end earnings conference call. At this time, you may disconnect and have a wonderful day.