Philip Morris International Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual report, not a standalone quarterly filing; fourth-quarter figures are included where disclosed. PMI sells cigarettes and smoke-free products outside the United States and is pursuing a strategy to replace cigarettes over time with reduced-risk products (RRPs), principally IQOS heated tobacco products.
Financial performance and key metrics
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Net revenues | $29.625 billion | $28.748 billion | +3.1% |
| Gross profit | $18.867 billion | $18.316 billion | +3.0% |
| Operating income | $11.377 billion | $11.581 billion | -1.8% |
| Net earnings attributable to PMI | $7.911 billion | $6.035 billion | +31.1% |
| Diluted EPS | $5.08 | $3.88 | +30.9% |
| Cash from operating activities | $9.478 billion | $8.912 billion | +$0.566 billion |
| Capital expenditures | $1.436 billion | $1.548 billion | -$0.112 billion |
| Total debt at year-end | $31.759 billion | $34.339 billion | -$2.580 billion |
Gross margin was approximately 63.7% in both years; operating margin was approximately 38.4%, down from 40.3%. Operating income excluding unfavorable currency was essentially flat. Net earnings and EPS rose mainly because the effective tax rate fell to 22.9% from 40.7% and net interest expense declined to $665 million from $914 million; operations reduced diluted EPS by $0.04, while currency reduced it by $0.11. The 2017 comparison included a $1.6 billion adverse tax effect from U.S. tax reform.
RRPs generated $4.096 billion of net revenues, up from $3.640 billion; combustible-product revenues were $25.529 billion, up from $25.107 billion. RRP revenue included approximately $0.9 billion from IQOS devices and accessories. Total cigarette and heated-tobacco-unit shipments declined 2.1% to 781.7 billion units. Cigarette shipments fell 2.8%, while heated tobacco unit shipments rose 14.2% to 41.4 billion. Excluding estimated distributor inventory movements—primarily in Japan—total shipments were flat. PMI’s estimated international share excluding China and the U.S. rose 0.5 points to 28.4%, including cigarette share of 26.8% and heated-tobacco share of 1.6%.
Fourth quarter: Net revenues were $7.499 billion versus $8.294 billion in Q4 2017; net earnings attributable to PMI were $1.910 billion versus $694 million, and diluted EPS was $1.23 versus $0.44. The filing attributes the low prior-year comparison chiefly to the 2017 tax-reform charge.
Cash flow, debt, and liquidity
- Operating cash flow was $9.478 billion; investing cash outflow was $998 million and financing cash outflow was $9.651 billion. Cash and cash equivalents ended the year at $6.593 billion, down from $8.447 billion.
- Operating cash flow less capital expenditures was approximately $8.042 billion in 2018, versus $7.364 billion in 2017; this is a simple calculation from reported figures, not a company-defined free-cash-flow measure.
- Total debt was $31.759 billion, including $4.054 billion of current long-term debt and $730 million of short-term borrowings. Weighted-average financing cost was 2.5%; long-term debt’s weighted-average maturity was 9.6 years.
- PMI reported $8.0 billion of committed revolving credit facilities, fully undrawn at year-end, and no commercial paper outstanding. Its covenant interest-coverage ratio was 10.5x against a 3.5x minimum. The current ratio was approximately 1.13x, compared with 1.35x a year earlier.
- Dividends paid totaled $6.885 billion. The quarterly dividend was raised 6.5% in 2018 to $1.14 per share; the stated annualized rate was $4.56. The company said it did not intend to repurchase shares in 2019.
Material changes and management commentary
- Net-revenue growth excluding currency was 3.4%, with favorable pricing partly offset by unfavorable volume and mix. Operating income excluding currency was approximately flat as pricing was offset by volume/mix and increased spending, especially investment in RRPs.
- East Asia & Australia was the main regional weakness: net revenues declined 12.4% and operating income declined 29.0%, reflecting Japan-related volume/mix and inventory effects and higher RRP investment. European Union revenue and operating income rose 11.8% and 11.2%, respectively; Latin America & Canada operating income increased 14.8%.
- PMI completed its analysis of the U.S. Tax Cuts and Jobs Act in 2018 and recorded a $31 million net tax charge relating to finalization of 2017 estimates. Management estimated a 2019 effective tax rate of approximately 23%, subject to tax-law developments and earnings mix.
- Capital expenditures were $1.436 billion, primarily supporting RRP capacity. Management expected approximately $1.1 billion of capital expenditures in 2019, funded from operating cash flows.
- PMI reported slower-than-projected IQOS growth in Japan in the first half of 2018 and said it initiated measures to address more conservative consumers. IQOS was available in 44 markets. The company’s U.S. FDA applications for IQOS remained under review; no approval or commercialization outcome was assured.
Risks, contingencies, and unusual items
- Major risks include declining cigarette consumption, excise-tax increases, regulation of tobacco and nicotine products, illicit trade, competition, currency volatility, geopolitical disruption, and the uncertain adoption, regulation, and supply chain of RRPs.
- PMI disclosed substantial tobacco litigation, including Quebec class-action judgments under appeal and cases with claimed damages in the billions. Management said it had not concluded that a loss was probable, could not estimate a possible loss range, and had accrued no estimated loss for pending tobacco-related cases. An adverse outcome could materially affect a period’s results or liquidity.
- Thai customs and tax criminal proceedings included government fine claims of approximately $2.57 billion and $630 million; the company cited a new customs law that substantially limits potential fines. Separately, Thai Customs revoked assessment notices totaling approximately $814 million. South Korean tax assessments paid by PMI’s affiliate while under appeal were approximately $243 million.
- Other notable items include Argentina’s adoption of highly inflationary accounting from July 1, 2018, and the $80 million annual commitment to the Foundation for a Smoke-Free World for 12 years. PMI also noted that certain RRPs use single- or limited-source components and rely on third-party device manufacturers.
- The balance sheet reported a stockholders’ deficit of $10.739 billion. PMI stated there were no off-balance-sheet arrangements other than disclosed guarantees and contractual obligations; guarantees of its own performance were approximately $0.3 billion.
Important facts for investors to verify
- Whether RRP revenue growth, adoption, margins, repeat use, and supply capacity can offset ongoing cigarette-volume declines; assess Japan shipment trends separately from distributor inventory movements.
- How much of the 2018 EPS increase reflects sustainable operating performance versus the lower tax rate and the unusual 2017 tax-reform comparison; review the 2019 tax-rate assumption and subsequent tax guidance.
- Current status and potential exposure from Quebec tobacco appeals, Thai proceedings, South Korean assessments, and shareholder litigation; compare developments with the filing’s no-accrual position.
- Debt maturities, cash generation after dividends and investment, and liquidity needs, including reliance on receivables sales and subsidiary-level borrowing arrangements.
- Regulatory and scientific developments affecting IQOS and other RRPs, including FDA review, marketing claims, taxation, and restrictions on commercialization.