Philip Morris International Inc. — Q1 2018 Form 10-Q
Business context and period. Unaudited results for the three months ended March 31, 2018; PMI manufactures and sells cigarettes and nicotine-containing products outside the United States. The company is investing in reduced-risk products (RRPs), including IQOS, and reorganized reporting into six geographic segments effective January 1, 2018. Comparatives were retrospectively adjusted for revenue presentation, among other changes. Net revenue excludes excise taxes.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change / comment |
|---|---|---|---|
| Net revenue | $6.896 billion | $6.064 billion | +13.7%; +8.3% excluding currency |
| Gross profit | $4.281 billion | $3.887 billion | Gross margin 62.1%, versus 64.1% |
| Operating income | $2.426 billion | $2.416 billion | +0.4% reported; down 2.7% excluding favorable currency. Operating margin 35.2%, versus 39.8% |
| Net earnings attributable to PMI | $1.556 billion | $1.590 billion | Down 2.1% |
| Diluted EPS | $1.00 | $1.02 | Down 2.0%; down 4.9% excluding favorable currency |
| Operating cash flow | $1.380 billion | $0.843 billion | Improved $0.537 billion |
| Investing cash flow | $(1.018) billion | $(0.543) billion | Higher use, including derivative collateral and capital spending |
| Financing cash flow | $(1.738) billion | $0.341 billion | 2018 included dividends and no new long-term debt proceeds |
| Cash and cash equivalents | $7.200 billion | $8.447 billion at Dec. 31, 2017 | Quarter-end balance decreased |
| Total debt | $34.8 billion | $34.3 billion at Dec. 31, 2017 | Current portion of long-term debt rose to $4.662 billion from $2.506 billion |
| Liquidity and covenants | $8.0 billion committed facilities, undrawn | — | $2.9 billion working-capital credit arrangements; covenant leverage ratio 10.3x versus 3.5x minimum |
Quarter-end current assets were $20.593 billion and current liabilities $17.688 billion. Dividends declared were $1.07 per share; $1.659 billion was paid during the quarter. PMI reported a stockholders’ deficit of $10.482 billion.
Material changes and operating trends
- RRP net revenue increased to $1.127 billion from $435 million, largely driven by Japan and Korea; combustible-product revenue rose 2.5% to $5.769 billion.
- Cigarette shipments declined 5.3%; heated tobacco unit shipments rose to 9.566 billion from 4.435 billion. Combined cigarette and heated tobacco shipments fell 2.3%, or 1.1% excluding estimated distributor inventory movements.
- Pricing, favorable currency and RRP sales supported revenue. Operating income excluding currency was pressured by unfavorable volume/mix, higher marketing and R&D spending, and the $80 million annual contribution to the Foundation for a Smoke-Free World.
- Regional operating income varied: Middle East & Africa fell 23.8% to $374 million, European Union fell 1.1% to $740 million, and Eastern Europe fell 5.0% to $151 million. South & Southeast Asia rose 15.9% to $429 million; East Asia & Australia rose 9.1% to $515 million; Latin America & Canada rose 23.3% to $217 million.
- Management attributed higher operating cash flow partly to lower working-capital requirements and the absence of the South Korean tax payment made in 2017. Capital expenditures were $365 million, primarily for RRP capacity expansion.
Outlook, commentary and risks
- On April 19, 2018, PMI forecast full-year reported diluted EPS of $5.25–$5.40, at then-prevailing exchange rates. This implied 8%–11% growth versus 2017 adjusted diluted EPS of $4.72, excluding an estimated favorable currency impact of about $0.16.
- Forecast assumptions: currency-neutral net revenue growth of approximately 8%; operating cash flow above $9 billion; capital expenditures of approximately $1.7 billion; effective tax rate of approximately 26%; and no share repurchases. PMI cautioned that tax-law interpretation, currency, earnings mix and other developments could change results.
- Japan RRP category growth was slower than initially projected in Q1; management said it was adjusting commercial plans. PMI reported no current IQOS device or heated-tobacco-unit capacity constraints, but noted reliance on third-party device makers and some single- or limited-source components.
- Key business risks include declining cigarette consumption, excise-tax increases and consumer down-trading, illicit trade, extensive regulation and marketing restrictions, currency movements, competition, and whether RRPs gain regulatory acceptance and consumer adoption.
- Tobacco litigation remains a material contingency. PMI had not concluded an unfavorable outcome was probable or estimable for pending tobacco-related cases and recorded no estimated loss for them. Canadian class-action judgments include substantial damages and remain under appeal. Thai customs/tax proceedings and South Korean tax assessments and investigations also remain relevant; some Thai assessments were reported as subject to cancellation or non-pursuit, with procedural finality still under review.
- The 2018 effective tax-rate estimate reflects ongoing analysis of the Tax Cuts and Jobs Act; the company said the final rate could differ. The 2017 comparison also included a $61 million tax benefit from a legal-entity restructuring.
Most important facts for investors to verify
- Whether RRP revenue growth and IQOS adoption can offset falling cigarette shipments, including the slower Q1 category growth in Japan.
- Whether pricing, product mix and operating cost trends can restore operating margins as RRP investment continues.
- The sustainability of operating cash flow, including the effects of receivables sales, working capital and derivative collateral; Q1 receivables sold totaled $2.509 billion.
- Debt maturities and refinancing needs, given $34.8 billion of total debt and the increased current portion, alongside the available credit facilities and covenant headroom.
- Developments in the Quebec tobacco litigation, Thai customs cases, South Korean tax matters and the company’s related exposures, which are uncertain and not accrued where losses were not deemed probable and estimable.
- Updates to the 2018 EPS, tax-rate, revenue-growth, cash-flow and capital-expenditure outlook, particularly as tax guidance, currency rates and market conditions change.