Philip Morris International Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited. PMI sells cigarettes and nicotine-containing products, including reduced-risk products (RRPs), outside the United States. Results are compared with Q1 2018 unless noted.
Financial results and key metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue including excise taxes | $17.705 billion | $18.426 billion | Down 3.9% |
| Net revenue | $6.751 billion | $6.896 billion | Down 2.1%; up 3.2% excluding currency |
| Gross profit | $4.286 billion | $4.281 billion | Up $5 million |
| Operating income | $2.050 billion | $2.426 billion | Down 15.5% |
| Net earnings attributable to PMI | $1.354 billion | $1.556 billion | Down 13.0% |
| Diluted EPS | $0.87 | $1.00 | Down 13.0% |
| Operating cash flow | $1.241 billion | $1.380 billion | Down $139 million |
| Capital expenditures | $324 million | $365 million | Down $41 million |
Margins: Gross margin was approximately 63.5% of net revenue versus 62.1% a year earlier; operating margin was approximately 30.4% versus 35.2%. PMI said operating income rose 9.1% excluding unfavorable currency and the RBH deconsolidation loss, Canadian litigation charge, and Pakistan plant impairment and exit costs.
Products and volume: RRP net revenue increased 10.3% to $1.243 billion, while combustible-product net revenue fell 4.5% to $5.508 billion. Total cigarette shipments were essentially flat at 164.3 billion units; heated tobacco unit shipments rose 20.2% to 11.5 billion. Total cigarette and heated tobacco unit shipments increased 1.1%. PMI estimated in-market sales growth of 1.7% after excluding an approximately 1.0 billion-unit unfavorable distributor inventory impact.
Cash, debt and liquidity: Cash and cash equivalents were $3.081 billion at March 31, down from $6.593 billion at year-end. Total debt was $30.3 billion, versus $31.8 billion at December 31, 2018. Current assets were $15.741 billion and current liabilities $18.486 billion. PMI had $8.0 billion of committed revolving facilities, fully available, and $989 million of commercial paper outstanding. Its revolving-facility covenant ratio was 10.8x against a 3.5x minimum. PMI paid $1.780 billion in dividends during the quarter.
Material changes and unusual items
- On March 22, 2019, PMI deconsolidated its Canadian subsidiary Rothmans, Benson & Hedges Inc. (RBH) after RBH entered creditor protection under Canada’s CCAA. PMI recorded a $239 million pre-tax deconsolidation loss and recognized its continuing RBH investment at a fair value of $3.280 billion. RBH’s cash and cash equivalents of approximately $1.323 billion were removed from PMI’s consolidated balance sheet.
- PMI recorded a $194 million pre-tax charge, or $142 million after tax, for its assessment of the Quebec class-action judgment amount considered probable and estimable. The charge related to a required trust deposit; the Canadian tobacco litigation remains subject to the CCAA process and a stay.
- A $20 million pre-tax impairment and exit-cost charge related to a Pakistan plant closure was recorded in South & Southeast Asia.
- The three items above reduced reported diluted EPS by approximately $0.22 in total. Currency reduced EPS by $0.06; lower interest expense and a lower tax rate partly offset these effects. PMI reported an effective tax rate of 22.6%, including a $49 million benefit from reversing a deferred tax liability related to RBH.
- Q1 investing cash flow included a $1.346 billion outflow associated with RBH deconsolidation. Financing cash outflow included approximately $2.1 billion of long-term debt repayments. PMI said operating cash flow was essentially flat year over year excluding unfavorable currency.
Outlook, management commentary and risks
- PMI estimated a full-year 2019 effective tax rate of approximately 23% and expected 2019 capital expenditures of approximately $1.1 billion.
- Management attributed currency-neutral net revenue growth to pricing, with unfavorable geographic cigarette mix largely offset by heated tobacco unit volume. It cited a challenging comparison with Q1 2018, including higher IQOS device shipments in Japan, and the effect of Argentina’s highly inflationary accounting treatment, effective July 1, 2018.
- PMI’s smoke-free strategy depends on consumer adoption, product performance, scientific substantiation, supply capacity and regulatory approval. The FDA’s review of PMI’s Platform 1 applications was ongoing; the filing gives no approval outcome. PMI noted that RRP adoption and performance are less predictable than its established cigarette business.
- Principal risks include tobacco regulation and taxation, declining cigarette consumption, illicit trade, foreign-exchange movements, competition, and litigation. PMI disclosed significant tobacco-related claims in multiple jurisdictions; it said losses on pending cases generally could not be estimated, except for amounts accrued where probable and estimable. Canadian litigation developments could materially change the estimated fair value of PMI’s RBH investment.
- Other disclosed exposures include Thai customs and tax criminal proceedings with large asserted fines, and tax examinations that could change unrecognized tax benefits. PMI stated it could not estimate potential changes from certain examinations.
Important facts for investors to verify
- Progress and potential financial consequences of RBH’s CCAA proceedings, including the Quebec litigation and the valuation and impairment risk of the $3.280 billion RBH investment.
- Whether RRP revenue and heated tobacco volumes can continue to grow, particularly in Japan, and how much marketing and product investment is required.
- Underlying operating performance excluding the $453 million of pre-tax RBH-related charges and the $20 million Pakistan charge, as well as the persistence of currency headwinds and pricing benefits.
- Cash generation and debt refinancing needs, including the effects of dividends, commercial paper, receivables sales and working-capital movements on liquidity.
- Updates to full-year tax and capital expenditure expectations, FDA and other regulatory decisions, and material developments in litigation or governmental investigations.