Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Philip Morris International Inc  (NYSE:PM)
Q3 2018 Earnings Conference Call
Oct. 18, 2018, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Philip Morris International Third Quarter 2018 Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by Philip Morris International management and the question-and-answer session. (Operator Instructions)

I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communication. Please go ahead, sir.

Nick Rolli -- Vice President-Investor Relations and Financial Communication

Welcome, and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2018 third quarter results. You may access the release on www.pmi.com or the PMI Investor Relations app. 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 are at the end of today's webcast slides, which are posted on our website.

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. Additionally, following the comprehensive business review that we provided at our recent Investor Day, today, we will summarize our 2018 full year outlook and third quarter results as well as our performance in select geographies.

For reference, the slides and transcripts for the Investor Day presentations are available on our website and our IR app.

It's now my pleasure to introduce Martin King, our Chief Financial Officer. Martin?

Martin King -- Chief Financial Officer

Thank you, Nick, and welcome, ladies and gentlemen. As announced this morning, we are reaffirming our 2018 reported diluted earnings per share guidance at prevailing exchange rates to be in a range of $4.97 to $5.02. Our guidance includes $0.12 of unfavorable currency and represents a growth rate, excluding currency, of approximately 8% to 9% compared to our adjusted diluted EPS of $4.72 in 2017.

Our guidance continues to reflect the full year assumptions shown on this slide and detailed in today's press release. Importantly, this includes PMI heated tobacco unit shipment volume of 41 billion to 42 billion units, reflecting a net anticipated distributor inventory reduction of approximately 3 billion units; and PMI heated tobacco unit in-market sales volume of 44 billion to 45 billion units.

Moving to our third quarter results. Total shipment volume decreased by 2.1%, due mainly to the impact of distributor inventory movements, notably related to heated tobacco units in Japan. Excluding inventory movements, total shipment volume increased by 1.1%, driven by higher heated tobacco unit volume in the EU, Japan, Korea, the Middle East and Africa region and Russia; as well as higher cigarette volume in select markets, notably Indonesia, Mexico, Saudi Arabia, Thailand and Turkey. September year-to-date, total shipment volume declined by 1.2%, but increased by 0.3%, excluding inventory movements.

Given the impact of distributor heated tobacco unit inventory movements on our third quarter 2018 results, let me take a moment to put this into perspective vis-à-vis the 3 billion-unit full year distributor inventory reduction assumption that we previously communicated. As seen on this chart, the full year reduction is driven by Japan and concentrated in the third quarter with a decrease of 3.7 billion units. By comparison, there was an inventory increase in the third quarter of 2017 of 3.2 billion units, resulting in a negative total heated tobacco unit inventory variance of 6.9 billion units.

For the fourth quarter this year, we anticipate a 0.5 billion unit inventory increase. This compares to an inventory increase of 7.3 billion units in the fourth quarter of 2017, resulting in a negative total heated tobacco unit inventory variance of 6.8 billion units. Importantly, heated tobacco unit inventories have been rightsized, and we are poised for future growth.

Third quarter net revenues increased by 3.3%, excluding currency, driven by strong pricing for our combustible tobacco portfolio, partly offset by the impact of the heated tobacco unit inventory adjustment that I just noted as well as unfavorable combustible tobacco volume/mix. Our currency-neutral net revenue growth in the quarter came in slightly above the approximately 2% growth expectation that we provided during Investor Day. As this difference mainly reflects timing between the third and fourth quarters, we are maintaining our full year net revenue growth assumption of approximately 3%, excluding currency. Given our September year-to-date growth of 6.5%, this implies a decline in the fourth quarter

of approximately 5%, largely reflecting the difficult comparison with the nearly 19% growth in the fourth quarter of 2017.

Adjusted operating income increased by 7.6%, excluding currency, reflecting the price-driven growth in net revenues, the favorable margin impact of lower IQOS device sales as well as lower manufacturing and marketing costs for combustible products, partly offset by incremental RRP investments across IQOS launch markets. Adjusted operating income margin increased by 1.8 points, excluding currency.

Our reported diluted EPS of $1.44 increased by 13.4% in the quarter, driven by favorable business performance, and also benefiting from the lower effective tax rate and lower interest expense compared to the third quarter of 2017. Excluding currency, adjusted diluted EPS increased by 20.5%. Demonstrating our favorable business momentum, total PMI international market share, excluding China and the US, increased by 0.5 points in the third quarter and by 0.6 points September year-to-date. The growth for both periods was driven by higher share for heated tobacco products, with the lower cigarette shares reflecting the impact of adult smoker out-switching to our heated tobacco brands. Indeed, our

cigarette shares within the cigarette category alone were stable.

As discussed in detail by our Chief Operating Officer, Jacek Olczak, during Investor Day, our combustible tobacco portfolio continues to be supported by robust fundamentals. This is evidenced by our third quarter combustible pricing variance of approximately 8%, driven notably by the EU region, Indonesia, the Philippines and Russia. Furthermore, our results reflect favorable cigarette share and/or volume trends across a range of key markets. For example, the decline in cigarette industry volume in Saudi Arabia moderated considerably in the quarter, reflecting the lapping of the June 2017 excise tax implementation.

Importantly, our market share increased by 6.1 points versus the third quarter of 2017, driven by Marlboro, L&M and Chesterfield, and was up by 1.6 points sequentially. In Turkey, strong cigarette industry volume growth continued in the quarter, supported by the lower prevalence of illicit trade. In addition, although our August quarter-to-date share declined slightly, share for Marlboro increased by 1.3 points. And in the Philippines, both Marlboro and Fortune drove total cigarette market share growth of 1.2 points in the quarter.

Marlboro's performance reflects the brand's strong equity in the market, while Fortune is benefiting from narrowed price gaps with lower-price brands.

Turning to the performance of IQOS. We are pleased with the growth in the total user base, which we believe serves as a leading indicator for market share. Indeed the positive sequential share performance for our heated tobacco brands continued in the quarter reaching 1.7% of total cigarette and heated tobacco unit industry volume, excluding China and the US. In Japan, our largest IQOS market, we recorded stable quarterly HeatSticks share on a sequential basis. This is encouraging given that we expect the range of initiatives that we have outlined previously, including the upcoming launch of IQOS 3 and IQOS 3 Multi, to only have a meaningful impact on share beginning in 2019.

Please note, the third quarter in-market sales for both cigarettes and heated tobacco units industrywide benefited from trade and consumer inventory movements in advance of the October 1 price increases.

In Korea, in-market sales volume for HEETS in the quarter was stable on a sequential basis at 1.4 billion units. Sequential share for HEETS declined, however, partly reflecting the impact of cigarette in-market sales volume seasonality. The sequential quarterly share trend for HEETS also reflects the impact of misleading comments by the KFDA earlier this year regarding the tar generated by IQOS as well as competitive churn associated with the increased distribution coverage of competitors' products.

As Jacek explained at Investor Day, the KFDA's comments have not really been an issue with regard to IQOS users that have already fully made the switch from cigarettes, and thus have discovered the various product attributes for themselves. Instead, the comments have been impacting those who are new to IQOS or were otherwise planning to enter the heated tobacco category. We remain focused on properly educating current IQOS users and adult smokers interested in the heated tobacco category on the differences between tobacco heating and combustion. We are committed to ensuring that these smokers receive accurate information to guide their choices.

In addition, the upcoming global launch of IQOS 3 devices, which includes Korea, should reinforce IQOS' status as the preeminent heated tobacco brand in the market.

In the EU region, the steady sequential growth of HEETS continued in the quarter, with share reaching 1.2% and reflecting further growth in the IQOS user base. It is also worth highlighting that our quarterly share for HEETS increased in all IQOS markets in the region compared to the third quarter of 2017.

Finally, we are particularly encouraged by the strong performance of IQOS in Russia. In the third quarter, share for HEETS reached 1.1% nationally, although our focus is currently on key cities comprising approximately 20% of the total cigarette market. Our disciplined approach to geographic and channel expansion allows us to ensure continued improvement in IQOS conversion rates and consumer experience.

To conclude, we delivered solid currency-neutral results in the third quarter, driven by strong pricing for our combustible product portfolio and benefiting at the EPS level from a lower effective income tax rate and lower interest expense. Our 2018 business outlook remains intact, supported by robust fundamentals for combustible products and increasingly broad-based IQOS growth across geographies. Consequently, we are reaffirming our 2018 reported diluted EPS guidance, which continues to represent a growth rate of approximately 8% to 9%, excluding currency, compared to adjusted diluted EPS of $4.72 in 2017.

Thank you. I'm now happy to answer your questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Adam Spielman of Citi.

Adam Spielman -- Citi -- Analyst

Thank you very much. So I have 2 questions. The simpler question is on FSA. This clearly did much better than I was expecting. And I suspect it's partly in the Philippines, but a large chunk is Indonesia. And I was wondering whether you think the good performances there is likely to continue into 2019 or whether you think it is a sort of short-term blip, if you like? That's my first question. I will come onto the second later.

Martin King -- Chief Financial Officer

Okay. Yes. The Philippines and Indonesia are both performing well. Philippines, Marlboro has been on a multiyear share growth trajectory that continues as the pricing in the market at the low end has moved up. And it is the preeminent brand in the market, so it continues to grow its share, which is helping lift the overall share. More recently, a positive has been also that Fortune has started to benefit from the price gaps as well. And so its growth has been very good from a share point of view. And obviously, with the price gaps closing and the trading to Marlboro as -- from a share perspective and Fortune, that's helped the profitability in the market. As far as we can see going forward, I think the Philippines will continue to be a good story with the single-tier tax there and the ability of our brands to continue to do very well. For Indonesia, the volume has been better than more recent times, as the market has stabilized. The total market size has stabilized. We're looking, probably for the full year, for it to be very slightly down. But it's very close now to being flat. Whereas before in previous couple of years, it's been down 1% to 2%, 2% to 3%. So that's a positive trend. We're doing very well in Indonesia with a couple of brands we introduced in the last 12 to 18 months, and that is the Dji Sam Soe Magnum Mild, and then also with the Marlboro Filter Black Kretek. They have both gained share very nicely, and they continue to do so. The challenge for us in Indonesia is with down-trading. As A Mild has moved through the 20,000 per pack -- rupiah per pack price point, it has lost some share. Over time, of course, other brands will move to that price point, and it should recover, but that's still going to take a bit longer to do. So I think Indonesia's on a good stable platform. Share is stable to slightly up, and it's been that way now for a good period of time. Obviously, we would like to see the share grow. We'd like to see A Mild start to do better. And I think that's just going to take some time as the pricing moves through the market. As you know, in Indonesia, you have lots of frequent price increases. So yes, very good news in that region.

Adam Spielman -- Citi -- Analyst

Okay. So perhaps the more significant question is about your guidance. Given your substantial beat, not only on the sales growth, but also on EBIT, I suppose I simply don't understand how your EPS can be as low as you say. In other words, I estimate that your sort of implying of EPS is it -- has to be down somewhat between like, 11% and 15% for 4Q to make your guidance, particularly is the shipping effects. In fact, one of your slides show the shipping effects on IQOS are fundamentally almost the same in 3Q and 4Q. I don't understand, given how good EPS was this quarter, why we should think it's going to be down double digit next quarter?

Martin King -- Chief Financial Officer

Yes, OK. So let's start at the revenue line. And the story there is really the comparison with the very high increase in Q4 of last year versus what's happening in Q4 this year. Actually, sequentially, from Q3 to Q4, if you do the math on the revenues to be down to 5% for the quarter versus last year and to be up 3% for the full year, you end up with revenues approximately the same in the fourth quarter is what we're seeing in the third quarter. So sequentially, it's not really the issue. On the other hand, when you compare Q4 to last year, you have several things going on, most of which relate to Japan. And that is you have the $7 billion almost impact on the inventory comparison year-over-year since we were building last year inventory. Whereas this year, the inventory is relatively flat. So that right there is a pretty significant comparison issue. You also pay back in Q4 in Japan the volume related to this recent pricing that occurred since retail and consumers loaded in the end of Q3. And so you will pay that back in Q4. That's probably around 1.5 billion sticks between conventional and heated tobacco units, that's just approximate. And then the other piece is the difference in device sales from last year to this year. Last year, we were bringing on the additional supplier and adding more volume into the market as we were getting ready to lift the cap in the end of January of this year. Whereas this year, we're launching 3 and 3 Multi. However, we have sufficient inventory of 2.4 plus. So the comparison year-over-year on devices is also another piece of that. If you carve out the rest of the business, the revenues are actually up about the same in Q4 of this year or will be. We anticipate Q4 this year versus Q4 last year around 5%. But the Japan effects are very significant when you add those impacts up. The other piece, when you take it down to the EPS level, is the cost pattern. We're still on track with the cost that we -- the spending increases that we mentioned before, around $600 million incremental on RRP, but a bigger piece of it comes in the fourth quarter. So we are stepping up the spending timing in the fourth quarter, overall, it's still more or less the same. And that's partly behind the 3 and 3 Multi launch around the world as well as other activities around RRP, where we're rolling out some of the efficiencies and improvements that we've been preparing all year. So it's all baked into the guidance. The 8% to 9% takes into account these issues as well as the pricing and everything else.

Adam Spielman -- Citi -- Analyst

So to summarize, just to make sure I don't misunderstand, sequentially, so think about it because I think this is the easiest, because you've got a $7 billion deload, in effect, in both quarters 3Q and 4Q, you expect roughly. Sequentially, when all is said and done, sales will be roughly the same, but EPS is going to go down sharply because you're investing more behind the version 3 device. I mean to me that sounds like the key difference between Q3 and Q4 when you come to the cost line if sales is going to be the same roughly.

Martin King -- Chief Financial Officer

Yes. I mean, revenue is more or less the same. I mean, obviously, there are other impacts in there like, as I mentioned, the timing on the pricing for Japan has an impact. And there are other movements around the world, both between Q3, Q4, et cetera. But, overall, I think it's all baked in.

Adam Spielman -- Citi -- Analyst

Okay. Thank you.

Operator

Our next question comes from the line of Judy Hong of Goldman Sachs.

Judy Hong -- Goldman Sachs -- Analyst

Thank you. Hi, everyone.

Martin King -- Chief Financial Officer

Hi, Judy.

Judy Hong -- Goldman Sachs -- Analyst

Martin, just the first question is on the IQOS next-gen 3 and the Multi launch in the fourth quarter. So it sounds like in Korea, they're announcing a launch next week. I'm just wondering from a timing perspective if you can just remind us sort of the phasing of the launch by different markets. Is Japan going first? And then Japan -- sorry, is Korea going first, and then Japan? Or kind of thinking about the timing around that is my first question.

Martin King -- Chief Financial Officer

Yes. It will become more clear in the next short period of time. But essentially, Japan and Korea are on the same time line. And we're getting ready for having a really successful introduction because we think these devices are a step forward and will help cement our already good position as the premium RRP brand in both of those markets.

Judy Hong -- Goldman Sachs -- Analyst

Got it. Okay. And then in Japan, so the inventory loading ahead of the price increases, I think you called out $1.5 billion in total in the third quarter. I'm just wondering if you can break out a little bit of just combustible versus the HeatSticks? And then I know it's early in the days, but kind of what are you seeing in terms of the consumer acceptance to those pricing and the volume elasticity around that?

Martin King -- Chief Financial Officer

Yes, OK. First of all, the prices have only been there a very, very short period of time. So it's too early to really see any patterns in how consumers are reacting. In Japan, just let me point out to make sure people understand. What I'm referring to is retail stores and consumers buying ahead of the price increase, which occurred in the third quarter. It doesn't have anything to do with our own shipments to distributors, et cetera. This is consumers. However, in the fourth quarter, obviously, consumers and retailers would reverse that. And so you could anticipate lower sales. As far as the exact amount, it's difficult to estimate a precise amount. I was giving a round number on the revenue just to give a sense for it. We think on heated tobacco units in Japan for the quarter, we were flat to maybe slightly up, if you exclude the inventory or the impact of the pricing. But that's just an estimate, right? So if you figure it was at $7.5 billion in there, if we figure it's about maybe 0.7, 0.8, 0.9, somewhere in that range and whereas cigarettes were around 0.6 or so, I mean, that's just a rough estimate, Judy. You don't really know until you see how it flows out into the consumers and how the prices are accepted. And it's too early to really see that yet.

Judy Hong -- Goldman Sachs -- Analyst

Got it, OK. And then just my last question just in terms of Russia. So nice to see continued price from improvement in that market. Just give us an update in terms of competitively what you're seeing in the marketplace and then sort of the sustainability of this more stable pricing environment in your view?

Martin King -- Chief Financial Officer

Yes. I mean, there's really no new news. The pricing continues to roll through pretty much as we've been talking throughout the year. We still see some down trading from the mid-price brands like our Bond Street to lower price. We actually see our premium Parliament, et cetera, holding up pretty well. But the pricing environment is more or less what we communicated in previous quarters, which means it's being pushed through. There are certain times when we see higher levels of inventory being used in order to delay the timing between announcing pricing versus when consumers actually get it. But there's really no new news on that front.

Judy Hong -- Goldman Sachs -- Analyst

Got it. Okay. Thank you.

Operator

Our next question comes from the line of Vivien Azer of Cowen and Company.

Vivien Azer -- Cowen and Company -- Analyst

Hi. Good morning.

Martin King -- Chief Financial Officer

Hi, Vivien.

Vivien Azer -- Cowen and Company -- Analyst

So my first question is on the EU, and the margin improvement continue to be quite strong on the heels of a good second quarter. Print as well. Anything to call out there in terms of geographic mix? Obviously, the pricing has been a bit better, but anything else to call out?

Martin King -- Chief Financial Officer

Well, I think Germany's been a bright spot with the performance of the brand Marlboro and we've seen some good results there. I mean, overall, across the EU, the bigger story is about the success on the heated tobacco units and IQOS. We're seeing very nice momentum across all the markets with growth. And you see it in the number of users, which is really the key metric to keep looking at because that for us is what tells us that we're converting smokers and locking in a better future as far as having higher margins and higher benefits for shareholders from the consumer. So EU's on a very good trajectory. But it's -- most of it, the most exciting part is the success of the heated tobacco units.

Vivien Azer -- Cowen and Company -- Analyst

Terrific. That's certainly encouraging to hear. My next question is on Saudi Arabia. Clearly, we understand the volume pressure from the excise taxes. And your market shares clearly look quite good, but there have been press reports that Saudi is looking to implement plain packaging. Any updates on that? And how are you thinking about potential impacts to your business? Thanks.

Martin King -- Chief Financial Officer

Yes. We don't have any new news on that. I mean, obviously, we're happy to be lapping the big or the implementation of excise. And that helps us as far as our comps moving forward, but we don't really have any other additional news in Saudi.

Vivien Azer -- Cowen and Company -- Analyst

Fair enough. My last question, please, is have you had any new engagement with the FDA on your IQOS applications? Thanks.

Martin King -- Chief Financial Officer

We're in the same place we were at Investor Day, which is we're hopeful that we would hear something on the PMTA by the end of this year. But it's really in the hands of the FDA, and we don't have anything more to add. I think we've covered it pretty well at Investor Day, and there's really nothing new on that front either.

Vivien Azer -- Cowen and Company -- Analyst

Excellent, thank you very much.

Operator

Our next question comes from the line of Michael Lavery of Piper Jaffray.

Michael Lavery -- Piper Jaffray -- Analyst

Good morning. Thank you.

Martin King -- Chief Financial Officer

Hey, Mike.

Michael Lavery -- Piper Jaffray -- Analyst

Just looking at the heated tobacco and the revenues you reported for that by segment, along with the HeatSticks volumes. I know you don't give the number of devices, which is a part of that. But just crudely calculating the revenue per stick, it looks like Russia or Eastern Europe has gone up considerably from last year and Middle East, Africa duty free and East Asia are down a bit. Can you just help us understand is device mix a big part of that? Have you had any lower pricing that has driven it? Have you seen the discount on the IQOS device in Japan that you made sort of basically permanent be a driver of that? How do we think about just some of that portfolio mix within the IQOS platform?

Martin King -- Chief Financial Officer

Well, yes. I mean, Russia is doing very well and continues to grow very nicely at a stepped-up pace from what it was sometime ago. Duty free is continuing to show good growth this year. I think you see the story for Japan and for Korea in the graphs that we showed during the presentation. The volume is stable to slightly up in Japan if you strip out the effects of the pricing. In Korea, it's stable. The number of devices sold is pretty much in line. It's lower than it was before. Partly with regard to Japan, of course, it was that we had sold it to our distributor there. And we've now been working off of those inventories as opposed to seeing new additional shipments, which would, in fact, impact revenue. They've been reduced to bring that inventory back in the line just as we've communicated we would do. And going forward in Q4, you're going to see the 3 and 3 Multi coming in. But as it's a new product and we're ramping up production, the year-over-year comparison on devices will be negative for Japan compared to Q4 last year. But other than that, I think you really get the effects of the growth offset by the inventory changes that we communicated for Japan.

Michael Lavery -- Piper Jaffray -- Analyst

Well, and so I realize you have all the data yourself, so you might not have a back of the envelope way like this. You would even look at it. But for example, in Eastern Europe, the price per stick -- the total IQOS revenues per HeatStick were up over 25%. Is that -- would that suggest a greater skew to devices? And if so, is that a potentially good leading indicator of increasing adoption with the stick sales to follow?

Martin King -- Chief Financial Officer

I'm not sure, I follow that. I mean, obviously, when we sell devices, it's flattering the revenue and until you have a consumer with the device, you don't get the stick sales. So there's a lag. So as you're opening a new market, you might see the revenues from the devices be a heavier proportion until you've converted smokers to it and then they start to purchase and repurchase the HeatSticks. So there's often a period of time where, when we look at a metric like HeatSticks per device sold in a newer market that would be relatively low. And then it would pick up steam as you convert more users. So some of these metrics can be affected by either very rapid growth, like what's happening in Russia, where you're converting a lot of people and selling devices, but then the HeatSticks lag that. So it depends on where the market is as far as whether it's stable from the point of view or whether it's adding users at a very fast pace versus a more mature state, where it's adding users, but maybe not as quickly. That might have something to do with some of your back-of-the-envelope calculations. But I'm not sure I can really help you with that.

Michael Lavery -- Piper Jaffray -- Analyst

No, that's very helpful. That's exactly the way it looks, so that's a great color. Just one more on HeatSticks and pricing. Can you just give us some of your thinking as the business now is getting to be 2 or more years old in many markets? As you're taking regular price increases on cigarettes, are you applying those to HeatSticks as well? I know typically you have some modest discounts. There's a small price gap relative to say Marlboro, for example. But when you're taking cigarette price increases, do HeatSticks tend to benefit from that as well?

Martin King -- Chief Financial Officer

Well, the best example is what we're doing in Japan right now. So we increased the price on Marlboro HeatSticks from JPY 470 to JPY 510 -- I mean, JPY 500, whereas we increased from the -- I'm sorry, from JPY 460 to JPY 500 on the Marlboro heated tobacco units, whereas the Marlboro cigarettes went from JPY 470 to JPY 510. So the increase was actually the same, but we kept a small differential in the price. So I think it's going to depend on each market. Obviously, we want our heated tobacco units to be premium products and we don't want to have too big a gap. The other piece that can influence it is how big is the tax benefit in each country and making sure that we pass some of that tax benefit where it's appropriate to consumers. So in general I think over the long haul, you'll see the pricing from heated tobacco units come, but it will depend on the situation in the market with regard to taxes and with regard to where we are as far as establishing the category and establishing the brand. Japan's the most mature of all and you see the pricing that occurred there recently, which kept gaps, but moved with cigarettes.

Michael Lavery -- Piper Jaffray -- Analyst

That's very helpful. Thank you very much.

Operator

Our next question comes from the line of Bonnie Herzog of Wells Fargo.

Bonnie Herzog -- Wells Fargo -- Analyst

All right. Thank you. Hi, Martin. I have a question on your total operating margin. It expanded nicely despite higher spending, and was probably driven by your lower IQOS device sales in the quarter. So I'm wondering, as you ramp your new device sales in Q4, how much of a negative impact will this have on your margins? And then actually maybe going back to an earlier question on your guidance, can you just explain why your EPS growth in Q4 won't be higher? And then as we think about next year and you continue to build or ramp your new device sales, just trying to get a sense of the impact this might have going forward on your margin?

Martin King -- Chief Financial Officer

Yes. So I think you're right to look at device sales as having an impact on the margin. And we actually called it out in previous quarters when we were shipping ahead of demand and had higher device sales as a percentage of net revenues for RRP. I mean, we've given this sort of rule of thumb, it's around 25%. But like in the first quarter, it was quite high. It was like 36%, and that dragged our margins a lot. Now you're seeing in Q3, it was lower because we were drawing down inventories, it was about 14%. So you see the benefit now swinging the other way when you compare. So over time, I think it works out to be around 25% of RRPs. But it's going to be variable depending on the timing of either inventory adjustments or of course launching additional devices. Now 3 and 3 Multi coming in now in the fourth quarter, we're obviously ramping up supply as well. So it's not as though we can ship as many as we would like, right? We have to live within what can be manufactured. So I don't know that you'll see such a huge surge of it, because of the fact that you have to get it distributed. You have to get it in consumers hands. You have to explain it. Plus you have to be able to manufacture it. So going forward, I think the 25% weighting is probably the best estimate, but it's going to vary.

Bonnie Herzog -- Wells Fargo -- Analyst

Okay. No, that's helpful. And then along those same lines, as you think about next year then we should expect these -- the new device sales to continue to sort of build especially in Q1 and probably Q2 and then depending on the demand throughout the year. So maybe it's not so front-end loaded? I'm just trying to get a sense of the phasing also as we look forward into 2019?

Martin King -- Chief Financial Officer

Yes. I'm not sure I can help you with much more than what I've just said. Keep in mind though, we will also continue to sell the 2.4 plus device in the markets. And we will use both as important ways to both reach more price sensitive consumers or newer consumers, who may not be willing to invest as much in a device with 2.4 plus, but use the 3 and 3 Multi as a more premium offering and giving consumers that consecutive experience option with the 3 Multi that's very important. I think it'll help us a lot in Japan and Korea especially, but also in other markets. So they both have a role to play going forward. And part of it's going to depend on how fast we convert consumers. Because obviously, as we ramp up our efforts and continue to get better at reaching consumers and converting consumers, you would need the devices to go with that.

Bonnie Herzog -- Wells Fargo -- Analyst

All right. And then actually it's a little bit along the lines of my next question, which was on the spending behind IQOS. You mentioned I think that Q4 spending might be a little bit higher again as you roll out these new devices. But just wanted to confirm that your total spending for the year in terms of incremental spend will still be around that $600 million range? And then just want to get a sense as we look forward, how should we think about any increased levels of spending you might need to do as, again, you're trying increased conversion? Will it be the same level next year? Or do you need to ramp that further?

Martin King -- Chief Financial Officer

Yes. The $600 million that we communicated earlier in the year is intact. We're on track for that. I was referring to the phasing of it, where it's a bit heavier in the fourth quarter to support the 3 and 3 Multi launch, but also some other initiatives. So it's more the weighting within the quarters that I was referring to. The total incremental spend, net of CC reallocations is intact at about $600 million. As far as next year, I'll just reiterate what we said before, which is that we expect that a chunk of that investment that we've made this year will support higher volumes going forward to next year. In other words, it won't need to be scaled with higher volumes and spread. Whereas there will be another portion, which we will need to continue to increase as we reach more consumers and as we move forward in additional geographies. So it'll be a mix. We are also, as we communicated at Investor Day, working hard at reallocating our spending and getting many efficiencies out of our current business as part of our transformation. That will be through various efforts, including the normal operations, activities around productivity and SKU rationalization supply chain, but also a new initiative around 0-based budgeting methodology to work hard on scrubbing our spending and making sure we're putting it to the great best use, some of which would be invested in improving revenue growth and helping to fund these investments that we need to make and some of which helps us with our step and our growth targets, where we're growing from at least 5% compound annual growth rate on revenue stepping up to the 8 -- at least 8% compound annual growth rate, x currency, both of them for the earnings per share.

Bonnie Herzog -- Wells Fargo -- Analyst

Okay. That's helpful. And then maybe just one final question for me, if I may. Just in terms of IQOS and the progression in different markets. You talked about the success you're having. And maybe you could highlight again, one or two markets that you're really excited about in terms of what you're seeing and where a couple of more markets could really take off? And then on the flip side of that, are there any markets right now that are possibly presenting some challenges or maybe similar in terms of complexity to what you've experienced in Japan, where you're at now in that market or possibly that give you pause, that would help. Just a couple of markets where you're super excited, and then maybe a couple that you're a little bit concerned about?

Martin King -- Chief Financial Officer

Yes. Well, first of all, I would say we have very broad geographic success with this product. It's doing well all across the EU, it's doing well across many, many, many markets. So it's hard to pick out just one or two to say they're particularly interesting. Russia is the one that we flagged and you've seen very positive momentum there. We've implemented a lot of the tools and approaches that we intend to spread to other markets later in Russia as something of our pilot or testing ground. And we've seen excellent success and excellent execution via the team in Russia around all sorts of tools with regard to digital and other approaches that we will continue to roll out in other markets as well. I mean, I think the big challenges we've talked about quite extensively being overcoming in Korea, this issue around misunderstanding caused by the misstatements that were made and trying to reach consumers and make sure they get the accurate message about what this product does do. And then, of course, in Japan where we have very good initiatives coming now very soon in the fourth quarter not just the 3 and 3 Multi launch, but also the HEETS launch at the mainstream price of JPY 470. And that will help us in the more price sensitive areas is where we'll start with it. And of course, the messaging, the approach to the consumer base, improving our execution across the whole line, we've been working very, very hard on that across all the markets, but it's actually focusing in on Japan and Korea. And we hope to see the benefits from these initiatives really start to show up essentially in 2019.

Bonnie Herzog -- Wells Fargo -- Analyst

Thank you.

Operator

Our next question comes from the line of Chris Growe of Stifel.

Chris Growe -- Stifel -- Analyst

Hi. Good morning,

Martin King -- Chief Financial Officer

Hi, Chris.

Chris Growe -- Stifel -- Analyst

Just had a couple of questions for you. I want to ask, within the combustible business, if you could speak to like the mix performance. You've had -- I guess, I'm thinking about in the context of having some conversions of discount brands around the world to global brands. And just probably mix overall has performed. It's probably a mixture of country and product mix in that question. but just curious if you have any statement, any comments on that?

Martin King -- Chief Financial Officer

Yes. We have been working at consolidating brands into the global brands for efficiency reasons. Because you can support centrally a campaign and an approach and a look and a feel for only a restricted number or smaller number of global brands. So moving some of the local brands in, a great example is what we did in Russia moving some brands into Philip Morris and being able to support it better. And you see Philip Morris growing in Russia. That's for efficiency reasons, but also for consumer reasons. It gives consumers a more established brand to migrate toward. I mean, obviously, there are some challenges around mix in certain countries. I mentioned Indonesia earlier where you have certain price points you're moving through and you have some down trading that occurs. Over time that can flow the other way. It depends on which brands are going through which price points. But we are focused on getting more efficient and working on consolidating our brands around the world.

Chris Growe -- Stifel -- Analyst

And just to reiterate is that movement to some of those global brands for more local brands, is that mix -- does that affect your mix? Is that a positive or a negative?

Martin King -- Chief Financial Officer

Well, in so far as you can over time establish a stronger brand, and then have it move up a bit in pricing, it can be more helpful. A lot of the smaller local brands tend to be at lower price points. So over time, if you can establish a Chesterfield or a Philip Morris in the market, you can move it up off the bottom of the pricing and get it, delivering a bit more benefit from a mix perspective.

Chris Growe -- Stifel -- Analyst

Okay. Thank you. And then I'm curious if you can say, how many markets do you expect for IQOS for it to be in for the year? Is that kind of continuing to increase overall? I think you made 43 before -- 42, 43 before?

Martin King -- Chief Financial Officer

Right now, we have lots of room to grow within the markets where we're already launched. In almost all the markets, except for a handful, we still are not completely national. We're focused more on bigger cities and on areas that are a good place to start, where we have opportunities to spread geographically. A good example of that is Russia, where we've seen tremendous success in the cities where we launched. But it's only representing 20% of the volume. So nationwide, we're at a little over 1% market share, 1.1%. But obviously in the focus areas where we launched, we're much higher than that. So we have plenty of room to grow in a lot of the markets where we've already launched. Now we do periodically add additional markets as it makes sense. Sometimes that's because neither the tax or the regulatory environment has finally gotten to where it supports this product, and we want to lock it in and go ahead and launch and get things going there. That's in some cases. In other cases, there are just markets we want to get going with because we think they show great promise. Now over the 3-year period, a longer period, then we would obviously have more markets than that. I'm talking about more the shorter-term period. So you'll see the markets quite creep up a bit in the next 6 to 12 months, but I don't think we'll be adding a large number of markets in that time period. Now as you go further out of course, we would like to get to some of the other big markets that we haven't addressed yet.

Chris Growe -- Stifel -- Analyst

Okay. And just one quick follow-up, which is on -- at the Investor Day, you showed a chart of an increase in shipments of -- I'm sorry, increase in sales of devices in July and August in Japan. There has been a resurgence there of device sales. Is that -- and we saw a little bit of an increase, at least sequentially that you gave at Investor Day in Japan HeatStick market share. Should we expect those devices to contribute to HeatStick volume in Japan? Is that -- do we see some of that already in, if you will, September for the quarter? And is that starting to increase a bit as you sell more devices there?

Martin King -- Chief Financial Officer

Well, obviously, we're focused on converting smokers into the category. In Japan, the category is still growing. We've added -- the whole heat-not-burn category has added well over 1 million new consumers over the course of the year and we're the biggest player in that. We're getting a very good proportion of that. So you need devices to continue to do that. We are selling devices to consumers as we convert them at a nice clip in Japan. You also though have replacement devices and particularly in markets like Japan. It's already been out there for a couple of years. You have consumers that want to replace their device. They want a second device. When it comes to 3 and 3 Multi, we could very well see consumers buy this as an additional device, not just for new consumers. We would expect quite a few of the existing consumers to be interested in the Multi, for example. So yes, we see good trends on device sales since we communicated, I think in May that was sort of the lower point. We've seen some nice recovery since then. Some of that is holders as well because we've been selling holders as well as the complete device. So I think we see a pretty good base and trend for optimism in Japan. As far as the volume and share, it's stable, right? It's not showing a big uptick. But we do expect these programs in the fourth quarter to start having the intended effect and our growth to be more occurring in 2019. We're very optimistic about what's coming in Japan.

Chris Growe -- Stifel -- Analyst

Okay. Thanks very much for your time.

Operator

Our next question comes from the line of Pamela Kaufman of Morgan Stanley.

Pamela Kaufman -- Morgan Stanley -- Analyst

Hi. Good morning. Thanks for the question. I just wanted to follow up a little bit more on Japan. And I was hoping you can elaborate on the competitive dynamics there in heat-not-burn, given some recent competitor product introductions over the last several months and competitors distribution expansion efforts over the last quarter.

Martin King -- Chief Financial Officer

Yes. It's nothing really new. We've been talking about the competitors that have expanded their distribution and they've obviously benefited from that. There were some supply constraints, especially on the part of -- with Japan Tobacco earlier in the year. So they've been gradually able to expand over the course of the year. We've shown before the places where the competitors have been the longest. In other words, where the churn has had some time to settle a bit. And you see there are share in places like Tokyo and Sendai and Fukuoka has been encouraging. And that trend is not any different, it continues. So it's really not new news on that front. We do see that consumers conversion rates to our product are very good and better than the competition and we do see that the product appreciation's higher. We have had the issue of reliability on our devices, which is much improved now. We showed at Investor Day the more recent production batches of the 2.4 plus have been increasingly more reliable and robust and much lower return rates, that continues. And we believe that 3 and 3 Multi are very well executed devices and will be able to help us in the competition with consumers. And so we're really encouraged. In fact, from the point of view of competition, it's actually good for the category for competitors to come with better products and have overall category grow faster. So we think we're in pretty good spot. We have great innovation machine that we showed at Investor Day to keep us ahead of the competition, and that's where we intend to stay. But we are not complacent about it. We're working hard on it.

Pamela Kaufman -- Morgan Stanley -- Analyst

Thanks. And just a question about the upcoming FDA PMTA meeting next week. What are your expectations for that meeting? And do you think that there might be any clarity on IQOS coming out of it?

Martin King -- Chief Financial Officer

Look, I don't have any new information with regard to the FDA from what we communicated at Investor Day. We're hopeful to hear from the FDA, but it's really in their hands. And I don't know that we're anticipating any particular meeting. That's going to be the big breakthrough. So there's really nothing new from what we communicated there.

Pamela Kaufman -- Morgan Stanley -- Analyst

Okay. Thank you.

Operator

And ladies and gentlemen, we have time for one more question. Our final question will come from the line of Adam Spielman of Citi.

Adam Spielman -- Citi -- Analyst

Thank you very much for allowing me a follow up question. One of the things that struck me in your presentation was the pricing variance in combustibles in the EU of 8%. I was just wondering if you could say where that came from in terms of geographies, is that sort of Germany mainly? And in particular, what's happening to France, because that

had negative variance, as I believe anywhere at the beginning of this year?

Martin King -- Chief Financial Officer

Yes. Germany is the biggest driver in EU pricing, and there's no new news on France. We still have the situation there of expected higher pack prices going forward that the government has communicated. And the pricing efficiency is not very good there because of the structure of the tax. So the overall pricing headwind that we have in France is still more or less what it was before.

Adam Spielman -- Citi -- Analyst

And if you hadn't mentioned after Germany, the sort of next to your biggest contributors?

Martin King -- Chief Financial Officer

Next to after Germany? Well, worldwide, it would be like Philippines and some of the other ones. Within EU, Germany is the biggest one. But we have pricing across the EU. I mean, in Poland, in Italy, there's pricing across the EU. It's really hard to flag any one market that's driving it other than Germany being the biggest one.

Adam Spielman -- Citi -- Analyst

Okay. Thank you very much.

Operator

And that was our final question. I'll turn the floor back over to management for any additional or closing remarks.

Martin King -- Chief Financial Officer

Yes. I just wanted to close with a couple of the key messages that we ended with at Investor Day. It starts with our commitment to the successful transformation to a smoke-free future. We think it's good for smokers, in particular, but also very good for shareholders. I think you've seen that the efforts are starting to bear fruit. In the volume numbers, the share numbers for this quarter gives us good momentum moving forward. It's built on that strong combustible tobacco business, which forms that foundation and a way for us to fund the transformation and get to a better place for shareholders. Very promising growth in RRPs across the geographies you heard about. We've got the innovation machine behind all this to try to stay ahead of it. And all of it supports the achievable 3-year currency neutral compound annual growth targets that we communicated at Investor Day around at least 5% for net revenues, x currency, and at least 8% for the adjusted diluted EPS. So I think our business is in good shape, we're showing good momentum, and we're looking forward to reporting the results going forward. Thanks very much, everybody, for being on the call.

Operator

Thank you. Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.

Duration: 59 minutes

Call participants:

Nick Rolli -- Vice President-Investor Relations and Financial Communication

Martin King -- Chief Financial Officer

Adam Spielman -- Citi -- Analyst

Judy Hong -- Goldman Sachs -- Analyst

Vivien Azer -- Cowen and Company -- Analyst

Michael Lavery -- Piper Jaffray -- Analyst

Bonnie Herzog -- Wells Fargo -- Analyst

Chris Growe -- Stifel -- Analyst

Pamela Kaufman -- Morgan Stanley -- Analyst

Adam Spielman -- Citi -- Analyst

More PM analysis

Transcript powered by AlphaStreet

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

Motley Fool Transcribers has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.