Philip Morris International Inc. quarterly report, Q3 FY2019

Philip Morris International Inc. — Q3 2019 Form 10-Q

Reporting period: Three and nine months ended September 30, 2019; unaudited U.S. GAAP financial statements. PMI sells cigarettes and smoke-free nicotine products primarily outside the United States. Management’s stated strategy is to expand smoke-free products while continuing its combustible-products business.

Financial performance

Metric	Q3 2019	Q3 2018	Nine months 2019	Nine months 2018
Net revenues	$7.642B	$7.504B	$22.092B	$22.126B
Operating income	$2.788B	$3.156B	$8.025B	$8.675B
Net earnings attributable to PMI	$1.896B	$2.247B	$5.569B	$6.001B
Diluted EPS	$1.22	$1.44	$3.57	$3.85

Q3 net revenue rose 1.8% reported and 3.4% excluding currency; nine-month net revenue was down 0.2% reported but up 4.1% excluding currency.
Operating income declined 11.7% in Q3 and 7.5% year to date. Excluding specified charges and currency, management reported operating-income growth of 1.3% in Q3 and 6.3% for the nine months.
Gross margin was approximately 65.9% in Q3 versus 65.1% a year earlier, and 65.0% for the nine months versus 63.9%. Operating margin was approximately 36.5% in Q3 versus 42.1%, and 36.3% year to date versus 39.2%.
Reduced-risk product (RRP) net revenue was $1.344B in Q3, up 63.4%, and $4.053B for the nine months, up 36.5%. Combustible-product net revenue fell 5.7% in Q3 and 5.8% year to date. Total cigarette and heated-tobacco-unit shipments declined 2.1% in Q3 and 0.9% year to date; heated tobacco unit shipments rose 84.8% and 45.7%, respectively.
Net interest expense was $132M in Q3 and $434M for the nine months, down 9.0% and 19.6%, respectively. Nine-month effective tax rate was 22.2%; Q3 rate was 24.1%.

Cash flow, debt and liquidity

Nine-month operating cash flow was $6.766B, down from $7.056B. Investing cash outflow was $1.627B, including $696M of capital expenditures and $1.346B of cash removed with RBH’s deconsolidation. Financing cash outflow was $5.102B, including $5.336B of dividends paid.
Cash and cash equivalents were $6.507B at September 30, 2019. Total debt was approximately $31.8B, broadly unchanged from year-end 2018; short-term borrowings were $355M. Cash less total debt implies net debt of approximately $25.3B.
PMI had $8.0B of committed revolving facilities, all available, and no commercial paper outstanding at quarter-end. Its revolving-credit covenant required EBITDA to interest expense of at least 3.5x; reported ratio was 11.1x. Current assets were $19.575B versus current liabilities of $18.045B.
Management expected 2019 capital expenditures of approximately $1.0B, revising down from the previously communicated $1.1B assumption. The quarterly dividend was raised 2.6% to $1.17 per share, or $4.68 annualized.

Material changes and unusual items

On March 22, 2019, PMI deconsolidated its Canadian subsidiary RBH after creditor-protection proceedings altered control. PMI recorded its continuing investment at a $3.280B fair value and a $239M pre-tax deconsolidation loss. The change also reduced reported revenue and segment results; RBH-related sales became related-party transactions.
PMI recorded a $374M pre-tax charge in Q3 for a Russian excise and VAT audit assessment, paid by its Russian affiliate. Management said the affiliate could challenge the assessment; the reported charge reduced Q3 diluted EPS by $0.20.
A $194M pre-tax charge was recorded in Q1 for Canadian tobacco litigation, and $65M of nine-month asset impairment and exit costs related to plant closures in Colombia and Pakistan. The Berlin factory closure proposal remained under employee consultation; no related costs were recorded, and potential costs were not yet determinable.
Q3 PMI-attributable earnings and diluted EPS fell 15.6% and 15.3%. For the nine months they fell 7.2% and 7.3%. Management’s reconciliation attributed $0.40 of the year-to-date EPS decline to listed 2019 charges and tax items, partly offset by operating performance, interest and tax effects.

Outlook, commentary and risks

Management estimated a full-year 2019 effective tax rate of approximately 23%, excluding specified discrete tax events and the RBH deconsolidation loss. The filing provides no clear full-year EPS or revenue guidance.
Management cited pricing and RRP growth as supports, offset by currency headwinds, declining cigarette volumes, higher investment in RRPs and the RBH deconsolidation. Q3 in-market sales, excluding RBH and estimated inventory movements, declined 3.6%; cigarette in-market sales fell 5.7%, partly offset by 28.3% growth in heated-tobacco-unit sales.
PMI described risks from regulation, excise taxes, illicit trade, competition, foreign exchange, litigation and governmental investigations. Tobacco-related claims include large potential damages in Canada, Brazil and Nigeria; management generally said it could not determine whether loss was probable or estimate a loss range for pending cases. Canadian tobacco litigation was stayed during RBH’s CCAA proceedings, then scheduled through March 12, 2020.
The FDA authorized a version of PMI’s Platform 1 product for U.S. sale in April 2019, subject to continuing marketing and reporting requirements; PMI’s separate modified-risk application remained under review. The company warned that RRP adoption, scientific acceptance, supply capacity and regulatory treatment remain uncertain.
Other watch items include Thai customs and tax criminal proceedings, a pending U.S. shareholder securities class action, currency and economic volatility, and possible regulatory changes affecting product marketing or access. Management reported disclosure controls effective and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether smoke-free product revenue growth and shipment trends persist, and how they translate into margins and cash flow as cigarette volumes decline.
Developments in RBH’s CCAA process, the recoverability and fair value of PMI’s $3.280B investment, and any effects of Canadian litigation resolution.
The status and potential financial impact of the Russian assessment challenge, Thai proceedings and other significant litigation or tax matters.
Reported versus adjusted operating performance, including the treatment and cash consequences of unusual charges, currency movements and inventory changes.
Debt maturities, dividend funding and liquidity, while noting that receivables sales supported operating cash flow: cumulative receivables sold were $7.8B during the nine-month period.
FDA authorization conditions and pending modified-risk review, as well as the regulatory, product-quality and supply-chain risks affecting RRPs.