Philip Morris International Inc. quarterly report, Q2 FY2018

Philip Morris International Inc. — Form 10-Q Summary

Reporting period: Quarter and six months ended June 30, 2018. Unaudited interim results; comparisons are with the corresponding 2017 periods. PMI sells cigarettes and other nicotine products outside the United States and is investing in reduced-risk products (RRPs), including IQOS.

Financial performance

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Net revenues	$7.726B	$6.917B	$14.622B	$12.981B
Operating income	$3.093B	$2.737B	$5.519B	$5.153B
Net earnings attributable to PMI	$2.198B	$1.781B	$3.754B	$3.371B
Diluted EPS	$1.41	$1.14	$2.41	$2.17
Operating cash flow	Not separately provided	Not separately provided	$5.373B	$4.071B

• Q2 net revenue increased 11.7%; operating income rose 13.0%; PMI-attributable earnings rose 23.4%; diluted EPS increased 23.7%. Excluding favorable currency, revenue grew 8.3%, operating income 9.8%, and EPS 20.2%.
• First-half net revenue increased 12.6%; operating income rose 7.1%; PMI-attributable earnings rose 11.4%; diluted EPS increased 11.1%. Excluding favorable currency, revenue grew 8.3%, operating income 3.9%, and EPS 7.8%.
• First-half gross margin was approximately 63.3%, versus 63.8% in 2017; operating margin was approximately 37.7%, versus 39.7%. Q2 operating margin improved to approximately 40.0% from 39.6%.
• First-half revenue growth reflected pricing, favorable currency, and volume/mix; growth in marketing, administration and research costs—including RRP investment and an $80 million Foundation for a Smoke-Free World contribution—limited operating-income growth. First-half net interest expense declined to $395 million from $432 million.
• RRPs generated $2.147B of first-half net revenue, versus $1.050B, and $1.020B in Q2, versus $615M. First-half cigarette shipments fell 3.3%, while heated tobacco unit shipments rose 90.6%; combined cigarette and heated tobacco shipments declined 0.6%.

Cash flow, debt and liquidity

• First-half operating cash flow was $5.373B. Management attributed the year-over-year increase partly to higher earnings and lower working-capital requirements, including timing of inventory and excise-tax payments and the prior-year South Korean tax payment.
• Capital expenditures were $774M in the first half. Investing cash use was $683M; financing cash use was $6.015B, including $2.483B of long-term debt repayments and $3.332B of dividends paid. Cash and cash equivalents ended June at $6.587B, down from $8.447B at year-end 2017.
• Total debt was approximately $31.7B, down from $34.3B at year-end; cash-adjusted debt was approximately $25.1B. Total liabilities were $50.9B against assets of $40.7B, resulting in stockholders’ deficit of $10.2B.
• PMI had $8.0B of committed revolving credit facilities, with no borrowings under them, and no commercial paper outstanding at quarter-end. It reported a 10.5-to-1.0 covenant ratio against a 3.5-to-1.0 minimum.
• Receivables sales were $5.3B during the first half; $0.6B remained outstanding at June 30. These sales contributed to reported operating cash flow.

Material changes and business developments

• PMI reorganized its reporting into six geographic segments beginning January 1, 2018. The prior-period revenue comparison was retrospectively adjusted to exclude excise taxes under the new revenue-recognition standard; management said adoption did not materially affect financial position or results.
• First-half segment operating income increased in five regions but fell in Middle East & Africa, where it declined 19.7% to $777M. South & Southeast Asia rose 26.1% to $869M. European Union operating income rose 13.3% to $1.917B, but declined 3.2% excluding currency.
• PMI acquired the remaining 49% of two Costa Rican affiliates for a net purchase price of $95M, bringing ownership to 100%.
• The board approved a 6.5% increase in the quarterly dividend to $1.14 per share; the annualized rate was $4.56. PMI said it did not intend to repurchase shares in 2018.

Outlook, commentary and risks

• On July 19, 2018, PMI forecast 2018 reported diluted EPS of $5.02–$5.12, versus $3.88 in 2017. Excluding an estimated $0.07 unfavorable currency effect, the forecast implied 8%–10% growth versus adjusted 2017 EPS of $4.72.
• Management forecast currency-neutral revenue growth of approximately 3%–4%, operating cash flow of approximately $9B, capital expenditures of approximately $1.5B, an effective tax rate of approximately 24%, and no share repurchases. It expected total cigarette and heated tobacco unit shipment volume to decline about 2%.
• The revised forecast reflected lower-than-expected IQOS device and heated tobacco unit consumer off-take, particularly in Japan, and inventory reductions. PMI anticipated approximately 41–42B heated tobacco unit shipments and 44–45B units of in-market sales for 2018, with a roughly 3B-unit inventory reduction concentrated in Q3. A new IQOS generation and Japanese marketing initiatives were expected to have limited 2018 benefit, with fuller impact in 2019.
• Management cited pricing and RRP growth as supports, but highlighted declining cigarette markets, excise-tax increases, down-trading, illicit trade, currency volatility, regulatory restrictions, competition, and uncertainty over RRP approvals and risk-claims as key risks. Effective July 1, 2018, Argentina would be treated as a highly inflationary economy; management estimated this would reduce full-year currency-neutral revenue growth by about 0.5 percentage points.
• PMI said no loss was accrued for pending tobacco litigation because management did not consider a loss probable and could not estimate a possible loss range. The Quebec Blais class-action judgment includes a trial-level allocation to PMI’s subsidiary of approximately CAD 3.1B in compensatory damages, under appeal; security of approximately CAD 226M had been furnished for the Quebec cases. Thai customs and tax proceedings also remained pending, with the company disputing the allegations.
• IQOS remains subject to regulatory review, including U.S. FDA applications. PMI’s scientific and commercial claims are subject to scrutiny; the filing notes that RRPs contain nicotine and are not risk-free. The filing also describes dependence on third-party device suppliers and single- or limited-source components.

Important facts for investors to verify

• Whether the $5.02–$5.12 EPS forecast and approximately 24% tax-rate assumption remain achievable, given currency, tax-law interpretation and operating trends.
• Japanese IQOS consumer off-take, device sales, inventory correction, and the difference between shipments and in-market sales.
• Cash-flow quality, including working-capital timing and the contribution from receivables sales, alongside the dividend and capital-spending commitments.
• Progress and potential exposure in Quebec tobacco litigation and Thai customs proceedings; no estimated tobacco-litigation loss was accrued.
• Regulatory decisions and scientific evidence affecting IQOS commercialization and permitted product claims, as well as execution and supply risks for RRPs.