PHILIP MORRIS INTERNATIONAL, INC. Description of Our Company
We are leading a transformation in the tobacco industry to create a smoke-free future and ultimately replace cigarettes with smoke-free products to the benefit of adultswho would otherwise continue to smoke, society, the company and its shareholders. We are a leading international tobacco company engaged in the manufacture and sale of cigarettes, as well as smoke-free products and associated electronic devices and accessories, and other nicotine-containing products in markets outsidethe United States . In addition, we ship a version of our Platform 1 device and its consumables authorized by theU.S. Food and Drug Administration ("FDA") to Altria Group, Inc. for sale inthe United States under license. We are building a future on a new category of smoke-free products that, while not risk-free, are a much better choice than continuing to smoke. Through multidisciplinary capabilities in product development, state-of-the-art facilities and scientific substantiation, we aim to ensure that our smoke-free products meet adult consumer preferences and rigorous regulatory requirements. Our IQOS smoke-free product brand portfolio includes heat-not-burn tobacco and nicotine-containing vapor products.
We manage our business in six operating segments:
•European Union ("EU"); •Eastern Europe ("EE");
•
business;
• South &
•
•
with Altria Group, Inc. for the distribution of our Platform 1 product in
the United States . Our cigarettes are sold in more than 180 markets, and in many of these markets they hold the number one or number two market share position. We have a wide range of premium, mid-price and low-price brands. Our portfolio comprises both international and local brands. In addition to the manufacture and sale of cigarettes, we are engaged in the development and commercialization of reduced-risk products ("RRPs"). RRPs is the term we use to refer to products that present, are likely to present, or have the potential to present less risk of harm to smokerswho switch to these products versus continuing smoking. We use the term net revenues to refer to our operating revenues from the sale of our products, including shipping and handling charges billed to customers, net of sales and promotion incentives, and excise taxes. Our net revenues and operating income are affected by various factors, including the volume of products we sell, the price of our products, changes in currency exchange rates and the mix of products we sell. Mix is a term used to refer to the proportionate value of premium-price brands to mid-price or low-price brands in any given market (product mix). Mix can also refer to the proportion of shipment volume in more profitable markets versus shipment volume in less profitable markets (geographic mix). Our cost of sales consists principally of: tobacco leaf, non-tobacco raw materials, labor and manufacturing costs; shipping and handling costs; and the cost of the IQOS devices produced by third-party electronics manufacturing service providers. Estimated costs associated with IQOS warranty programs are generally provided for in cost of sales in the period the related revenues are recognized. Our marketing, administration and research costs include the costs of marketing and selling our products, other costs generally not related to the manufacture of our products (including general corporate expenses), and costs incurred to develop new products. The most significant components of our marketing, administration and research costs are marketing and sales expenses and general and administrative expenses.Philip Morris International Inc. is a legal entity separate and distinct from its direct and indirect subsidiaries. Accordingly, our right, and thus the right of our creditors and stockholders, to participate in any distribution of the assets or earnings of any subsidiary is subject to the prior rights of creditors of such subsidiary, except to the extent that claims of our company itself as a creditor may be recognized. As a holding company, our principal sources of funds, including funds to make payment on our debt securities, are from the receipt of dividends and repayment of debt from our subsidiaries. Our principal wholly owned and majority-owned -46-
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subsidiaries currently are not limited by long-term debt or other agreements in their ability to pay cash dividends or to make other distributions with respect to their common stock that are otherwise compliant with law. Executive Summary The following executive summary provides the business update and significant highlights from the "Discussion and Analysis" that follows.
Consolidated Operating Results for the Six Months Ended
• Net Revenues - Net revenues of
30, 2020 decreased by
and were impacted by the effects of the COVID-19 pandemic, particularly in
the second quarter of 2020. The change in our net revenues from the
comparable 2019 amount was driven by the following (variances not to scale
with year-to-date results):
[[Image Removed: chart-23913c1e43e95fb29d2.jpg]]
For the six months ended June 30, 2020 , net revenues, excluding unfavorable
currency, decreased by 1.8%, reflecting: unfavorable volume/mix, primarily due
to lower cigarette volume (mainly in Australia , Indonesia , Italy , Japan , Mexico ,
the Philippines , PMI Duty Free, Poland , Spain and Turkey , partly offset by
Germany ) and lower IQOS device volume (primarily in Japan ), partially offset by
higher heated tobacco unit volume (notably in the EU, Japan , Russia and Ukraine ,
partly offset by PMI Duty Free); and the unfavorable impact of $227 million ,
shown above, mainly resulting from the deconsolidation of our Canadian
subsidiary, Rothmans, Benson & Hedges, Inc. ("RBH"), effective March 22, 2019 ;
partly offset by a favorable pricing variance (notably driven by Australia , the
GCC, Germany , Mexico , and the Philippines , partially offset by Indonesia ). For
further details on the deconsolidation of RBH, see Note 8. Contingencies and
Note 19. Deconsolidation of RBH.
Net revenues by product category for the six months ended June 30, 2020 and 2019
are shown below:
[[Image Removed: chart-242e97a6fdd758b9bd5.jpg]] [[Image Removed: chart-6b9c349c9f7c5920990.jpg]]
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• Diluted Earnings Per Share - The changes in our reported diluted earnings per
share ("diluted EPS") for the six months ended June 30, 2020 , from the
comparable 2019 amounts, were as follows:
% Growth
Diluted EPS (Decline)
For the six months ended June 30, 2019 $ 2.36
2019 Asset impairment and exit costs 0.02
2019 Canadian tobacco litigation-related expense 0.09
2019 Loss on deconsolidation of RBH 0.12
2019 Tax items (0.04 )
Subtotal of 2019 items 0.19
2020 Asset impairment and exit costs (0.04 )
2020 Fair value adjustment for equity security investments (0.04 )
2020 Tax items -
Subtotal of 2020 items (0.08 )
Currency (0.19 )
Interest -
Change in tax rate 0.02
Operations 0.12
For the six months ended June 30, 2020 $ 2.42 2.5 %
Asset impairment and exit costs - We recorded pre-tax asset impairment and exit costs of$71 million (or$0.04 per share impact on diluted EPS) during the six months endedJune 30, 2020 , related to the organizational design optimization plan inSwitzerland andNew York, U.S.A. We recorded pre-tax asset impairment and exit costs of$43 million (or$0.02 per share impact on diluted EPS) during the six months endedJune 30, 2019 , related to cigarette plant closures inColombia andPakistan as part of the optimization of our global manufacturing footprint. The total pre-tax charges were included in marketing, administration and research costs on the condensed consolidated statements of earnings. For further details, see Note 18. Asset Impairment and Exit Costs. Canadian tobacco litigation-related expense - In the first quarter of 2019, we recorded a pre-tax charge of$194 million , representing$142 million net of tax, relating to the judgment against our Canadian subsidiary,Rothmans, Benson & Hedges Inc. ("RBH"), in twoQuébec smoking and health class actions. The charge of$0.09 per share reflects our assessment of the portion of the judgment that represents probable and estimable loss prior to the deconsolidation of RBH and corresponds to the trust account deposit required by the judgment. The total pre-tax charge was included in marketing, administration and research costs on the condensed consolidated statements of earnings and was included in the operating income of theLatin America &Canada segment. For further details, see Note 8. Contingencies and Note 19. Deconsolidation of RBH. Loss on deconsolidation of RBH - Following the judgment in the twoQuébec smoking and health class actions, RBH obtained an initial order from theOntario Superior Court of Justice granting it protection under the Companies' Creditors Arrangement Act ("CCAA"), which is a Canadian federal law that permits a Canadian business to restructure its affairs while carrying on its business in the ordinary course with minimal disruption to its customers, suppliers and employees. The administration of the CCAA process, principally relating to the powers provided to the court and the court appointed monitor, removes certain elements of control of the business from both PMI and RBH. As a result, we have determined that we no longer have a controlling financial interest over RBH and that we do not exert "significant influence" over RBH underU.S. GAAP. Therefore, we deconsolidated RBH as of the date of the CCAA filing onMarch 22, 2019 , and will account for our continuing investment in RBH as an equity security, without readily determinable fair value. A loss on the deconsolidation of RBH of$239 million was included in marketing, administration and research costs on the condensed consolidated statements of earnings for the six months endedJune 30, 2019 and was included in the operating income of theLatin America &Canada segment. The$0.12 per share impact also included a tax benefit of$49 million within the provision for income taxes, as discussed above, related to the reversal of a deferred tax liability on the unremitted earnings of RBH. For further details, see Note 8. Contingencies and Note 19. Deconsolidation of RBH. -48-
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Fair Value adjustment for equity security investments - During the six months endedJune 30, 2020 , we recorded an unfavorable fair value adjustment for our equity security investments of$62 million after tax (or$0.04 per share decrease in diluted EPS). The fair value adjustment for our equity security investments was included in equity investments and securities (income)/loss, net ($78 million loss) and provision for income taxes ($16 million benefit) on the condensed consolidated statements of earnings. For further details, see Note 11. Fair Value Measurements. Income taxes - The 2019 Tax items that increased our 2019 diluted EPS by$0.04 per share in the table above were primarily due to a reduction in estimatedU.S. federal income tax on dividend repatriation for the years 2015 - 2018 ($67 million ). The change in the effective tax rate that increased our diluted EPS by$0.02 per share in the table above was primarily due to changes in earnings mix by taxing jurisdiction and the corporate income tax rate reduction inIndonesia . For further details, see Note 9. Income Taxes. Currency - The unfavorable impact of$0.19 per share during the reporting period results from the fluctuations of theU.S. dollar, especially against the Brazilian real, Euro, Mexican pesos, Russian ruble and Swiss franc. This unfavorable currency movement has impacted our profitability across our primary revenue markets and local currency cost bases.
Operations - The increase in diluted EPS of
•
manufacturing costs, partially offset by higher marketing, administration and
research costs;
•
lower manufacturing costs and favorable pricing, partially offset by
unfavorable volume/mix; and
•
by higher marketing, administration and research costs and higher
manufacturing costs;
partially offset by
•
distribution rights billed to customers in certain markets, partially offset
by favorable pricing;
•
impact resulting from the deconsolidation of RBH, partially offset by
favorable pricing; and
• South &
pricing, lower marketing, administration and research costs, and lower
manufacturing costs.
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Consolidated Operating Results for the Three Months Ended
• Net Revenues - Net revenues of
30, 2020 decreased by
amount, and were significantly impacted by the effects of the COVID-19
pandemic. The change in our net revenues from the comparable 2019 amount was
driven by the following (variances not to scale with quarterly results):
[[Image Removed: chart-a047954e593558989c9.jpg]]
During the quarter, net revenues, excluding unfavorable currency, decreased by
9.5%, mainly reflecting: unfavorable volume/mix, primarily due to lower
cigarette volume (mainly in Indonesia , Italy , Japan , Mexico , the Philippines ,
PMI Duty Free and Russia , partly offset by Saudi Arabia ), partially offset by
higher heated tobacco unit volume (notably in the EU, Japan and Russia , partly
offset by PMI Duty Free); partially offset by a favorable pricing variance
(notably driven by Germany , Mexico , the Philippines , Russia and Saudi Arabia ,
partly offset by Indonesia and Turkey ).
Net revenues by product category for the three months ended June 30, 2020 and
2019, are shown below:
[[Image Removed: chart-cfa22ea34b09581fab9.jpg]] [[Image Removed: chart-1f28bd2874f75a51baf.jpg]]
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• Diluted Earnings Per Share - The changes in our reported diluted EPS for the
three months ended June 30, 2020 , from the comparable 2019 amounts, were as
follows:
Diluted EPS % Growth (Decline)
For the three months ended June 30, 2019 $ 1.49
2019 Asset impairment and exit costs 0.01
2019 Tax items (0.04 )
Subtotal of 2019 items (0.03 )
2020 Asset impairment and exit costs (0.04 )
2020 Fair value adjustment for equity security investments -
2020 Tax items -
Subtotal of 2020 items (0.04 )
Currency (0.06 )
Interest (0.01 )
Change in tax rate 0.03
Operations (0.13 )
For the three months ended June 30, 2020 $ 1.25 (16.1 )%
Asset impairment and exit costs - We recorded pre-tax asset impairment and exit costs of$71 million (or$0.04 per share impact on diluted EPS) during the three months endedJune 30, 2020 , related to the organizational design optimization plan inSwitzerland andNew York, U.S.A. We recorded pre-tax asset impairment and exit costs of$23 million (or$0.01 per share impact on diluted EPS) during the three months endedJune 30, 2019 , related to a cigarette plant closure inColombia as a part of the optimization of our global manufacturing footprint. The total pre-tax charges were included in marketing, administration and research costs on the condensed consolidated statements of earnings. For further details, see Note 18. Asset Impairment and Exit Costs. Income Taxes - The 2019 Tax items that increased our 2019 diluted EPS by$0.04 per share in the table above were primarily due to a reduction in estimatedU.S. federal income tax on dividend repatriation for the years 2015 - 2018 ($67 million ). The change in the tax rate that increased our diluted EPS by$0.03 per share in the table above was primarily due to changes in earnings mix by taxing jurisdiction and the corporate income tax rate reduction inIndonesia . For further details, see Note 9. Income Taxes. Currency - The unfavorable impact of$0.06 per share in the second quarter results from the fluctuations of theU.S. dollar, especially against the Indonesian rupiah, Mexican pesos and Russian ruble. This unfavorable currency movement has impacted our profitability across our primary revenue markets and local currency cost bases.
Operations - The decrease in diluted EPS of
•
pricing;
• South &
partially offset by lower marketing, administration and research costs, and
lower manufacturing costs; and
•
pricing;
partially offset by
•
offset by higher marketing, administration and research costs;
•
lower manufacturing costs and favorable pricing, partially offset by
unfavorable volume/mix; and
•
volume/mix, partially offset by higher marketing, administration and research
costs.
For further details, see the "Consolidated Operating Results" and "Operating Results by Business Segment" sections of the
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following "Discussion and Analysis."
COVID-19 Impact on Our Business
COVID-19: Business Continuity Update
Since the onset of COVID-19, PMI has undertaken a number of business continuity measures to mitigate potential disruption to its operations and route-to-market in order to preserve the availability of products to its customers and adult consumers.
Currently, PMI has sufficient access to the inputs for its products and is not facing any significant business continuity issues with respect to key suppliers.
The large majority of PMI's manufacturing facilities globally are currently operational, including all heated tobacco unit factories. Certain cigarette production facilities are temporarily impacted by government-mandated shutdowns or production limitations. Such facilities account for less than 5% of PMI's total cigarette production capacity worldwide. Based on current sales trends, there are adequate inventories of PMI finished goods across all key markets for cigarettes and across all IQOS markets for heated tobacco units and tobacco heating devices. While government-related restrictions have led to complexities in the company's route-to-market in select geographies, PMI does not currently anticipate out-of-stock situations in any major operating income markets and generally expects consumers to have adequate access to its products. PMI has sufficient liquidity resources through cash on hand, the ongoing cash generation of its business, and its access to the commercial paper and debt markets. As ofJune 30, 2020 , the company had approximately$4.2 billion of cash and cash equivalents. The company has a well laddered bond portfolio, and onMay 1, 2020 , issued a three-tranche bond offering totaling$2.25 billion , equally split among three, five and 10-year maturities. PMI has a$0.3 billion (equivalent) bond maturing inSeptember 2020 . For further details on our liquidity position, see the "Financial Review" section of this MD&A. -52-
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Discussion and Analysis
Consolidated Operating Results
See pages 90-96 for a discussion of our "Cautionary Factors That May Affect
Future Results." Our net revenues and operating income by segment are shown in
the table below:
For the Six Months Ended For the Three Months Ended
(in millions) June 30, June 30,
2020 2019 2020 2019
Net revenues:
European Union $ 5,010 $ 4,736 $ 2,475 $ 2,577
Eastern Europe 1,571 1,401 783 822
Middle East & Africa 1,580 1,931 704 1,004
South & Southeast Asia 2,140 2,361 889 1,248
East Asia & Australia 2,687 2,842 1,432 1,521
Latin America & Canada (1) 816 1,179 368 527
Net revenues $ 13,804 $ 14,450 $ 6,651 $ 7,699
Operating income (loss):
European Union $ 2,336 $ 2,091 $ 1,178 $ 1,195
Eastern Europe 365 385 266 256
Middle East & Africa 558 785 237 441
South & Southeast Asia 888 932 289 492
East Asia & Australia 1,155 1,069 669 642
Latin America & Canada (1) 218 (25 ) 92 161
Operating income $ 5,520 $ 5,237 $ 2,731 $ 3,187 (1) As of
Items affecting the comparability of results from operations were as follows:
• Canadian tobacco litigation-related expense - See Note 8. Contingencies and
Note 19. Deconsolidation of RBH for details of the
charge included in the
ended
• Loss on deconsolidation of RBH - See Note 19. Deconsolidation of RBH for
details of the
segment for the six months ended
• Asset impairment and exit costs - See Note 18. Asset Impairment and Exit
Costs for a breakdown of these costs by segment for the six months and three
months ended June 30, 2020 and 2019.
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Our net revenues by product category are shown in the table below:
PMI Net Revenues by Product Category
(in millions) For the Six Months Ended June 30 ,
For the Three Months Ended
2020 2019 Change 2020 2019 Change
Combustible Products
European Union $ 3,855 $ 3,961 (2.7 )% $ 1,945 $ 2,149 (9.5 )%
Eastern Europe 1,045 1,110 (5.9 )% 522 640 (18.3 )%
Middle East & Africa 1,528 1,746 (12.5 )% 696 918 (24.2 )%
South & Southeast Asia 2,140 2,361 (9.4 )% 889 1,248 (28.8 )%
East Asia & Australia 1,272 1,394 (8.8 )% 630 756 (16.7 )%
Latin America & Canada 803 1,168 (31.3 )% 363 522 (30.5 )%
Total Combustible Products $ 10,643 $ 11,741 (9.4 )% $ 5,045 $ 6,233 (19.1 )%
Reduced-Risk Products
European Union $ 1,155 $ 775 49.0 % $ 530 $ 428 23.9 %
Eastern Europe 526 291 81.0 % 261 182 42.9 %
Middle East & Africa 52 185 (72.0 )% 8 86 (90.6 )%
South & Southeast Asia - - - % - - - %
East Asia & Australia 1,415 1,448 (2.3 )% 802 765 4.9 %
Latin America & Canada 13 11 24.4 % 5 5 7.9 %
Total Reduced-Risk Products $ 3,161 $ 2,709 16.7 % $ 1,606 $ 1,466 9.5 %
Total PMI Net Revenues $ 13,804 $ 14,450 (4.5 )% $ 6,651 $ 7,699 (13.6 )%
Note: Sum of product categories or Regions might not foot to total PMI due to roundings.
Net revenues related to combustible products refer to the operating revenues generated from the sale of these products, including shipping and handling charges billed to customers, net of sales and promotion incentives, and excise taxes. These net revenue amounts consist of the sale of our cigarettes and other tobacco products combined. Other tobacco products primarily include roll-your-own and make-your-own cigarettes, pipe tobacco, cigars and cigarillos and do not include reduced-risk products. Net revenues related to reduced-risk products refer to the operating revenues generated from the sale of these products, including shipping and handling charges billed to customers, net of sales and promotion incentives, and excise taxes. These net revenue amounts consist of the sale of our heated tobacco units, IQOS devices and related accessories, and other nicotine-containing products, which primarily include our e-vapor products.
We recognize revenue when control is transferred to the customer, typically either upon shipment or delivery of goods.
Revenues from shipments of Platform 1 devices, heated tobacco units and
accessories to Altria Group, Inc., commencing in the third quarter of 2019, for
sale under license in
References to "Cost/Other" in the Consolidated Financial Summary table of total PMI and the six operating segments throughout this "Discussion and Analysis" reflects the currency-neutral variances of: cost of sales (excluding the volume/mix cost component); marketing, administration and research costs (including asset impairment and exit costs, the Canadian tobacco litigation-related expense, and the charge related to the deconsolidation of RBH inCanada ); and amortization of intangibles. "Cost/Other" also includes the currency-neutral net revenue variance, unrelated to volume/mix and price components, attributable to fees for certain distribution rights billed to customers in certain markets in theME&A Region , as well as the impact of the deconsolidation in RBH. -54-
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Our shipment volume by segment for cigarettes and heated tobacco units is shown in the table below:
PMI Shipment Volume (Million Units)
For the Six Months Ended June 30 , For
the Three Months Ended
2020 2019 Change 2020 2019 Change
Cigarettes
European Union 80,963 85,855 (5.7 )% 40,317 46,367 (13.0 )%
Eastern Europe 45,076 47,400 (4.9 )% 23,657 27,080 (12.6 )%
Middle East & Africa 57,184 64,963 (12.0 )% 27,188 31,659 (14.1 )%
South & Southeast Asia 70,941 87,868 (19.3 )% 33,346 46,376 (28.1 )%
East Asia & Australia 24,370 25,958 (6.1 )% 12,071 13,845 (12.8 )%
Latin America & Canada 29,843 36,052 (17.2 )% 14,780 18,472 (20.0 )%
Total Cigarettes 308,377 348,096 (11.4 )% 151,359 183,799 (17.6 )%
Heated Tobacco Units
European Union 8,888 5,336 66.6 % 4,227 3,043 38.9 %
Eastern Europe 9,492 4,355 +100% 5,126 2,807 82.6 %
Middle East & Africa 655 1,473 (55.5 )% 185 719 (74.3 )%
South & Southeast Asia - - - % - - - %
East Asia & Australia 16,198 15,277 6.0 % 9,076 8,428 7.7 %
Latin America & Canada (1) 202 113 78.8 % 94 59 59.3 %
Total Heated Tobacco Units 35,435 26,554 33.4 % 18,708 15,056 24.3 %
Cigarettes and Heated Tobacco
Units
European Union 89,851 91,191 (1.5 )% 44,544 49,410 (9.8 )%
Eastern Europe 54,568 51,755 5.4 % 28,783 29,887 (3.7 )%
Middle East & Africa 57,839 66,436 (12.9 )% 27,373 32,378 (15.5 )%
South & Southeast Asia 70,941 87,868 (19.3 )% 33,346 46,376 (28.1 )%
East Asia & Australia 40,568 41,235 (1.6 )% 21,147 22,273 (5.1 )%
Latin America & Canada 30,045 36,165 (16.9 )% 14,874 18,531 (19.7 )%
Total Cigarettes and Heated
Tobacco Units 343,812 374,650 (8.2 )% 170,067 198,855 (14.5 )%
(1) Includes shipments to Altria Group, Inc., commencing in the third quarter of
2019, for sale in
Following the deconsolidation of our Canadian subsidiary, we will continue to report the volume of brands sold by RBH for which other PMI subsidiaries are the trademark owners. These include HEETS, Next, Philip Morris and Rooftop.
Heated tobacco units ("HTU") is the term we use to refer to heated tobacco
consumables, which for us include our HEETS, HEETS Creations, HEETS Marlboro and
HEETS FROM
Market share for HTUs is defined as the total sales volume for HTUs as a percentage of the total estimated sales volume for cigarettes and HTUs.
Shipment volume of heated tobacco units to
References to total international market, defined as worldwide cigarette and heated tobacco unit volume excludingthe United States , total industry, total market and market shares throughout this "Discussion and Analysis" are our estimates for tax-paid products based on the latest available data from a number of internal and external sources and may, in defined instances, exclude -55-
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the People's Republic of China and/or our duty free business. In addition, to reflect the deconsolidation of RBH, effectiveMarch 22, 2019 , PMI's total market share has been restated for previous periods.
Estimates for second-quarter 2020 and six months year-to-date 2020 total industry volume and market share in certain geographies reflect limitations on the availability and accuracy of industry data during pandemic-related restrictions.
In-market sales ("IMS") is defined as sales to the retail channel, depending on the market and distribution model.
Unless otherwise stated, references to total industry, total market, our shipment volume and our market share performance reflect cigarettes and heated tobacco units.
From time to time, PMI's shipment volumes are subject to the impact of
distributor inventory movements, and estimated total industry/market volumes are
subject to the impact of inventory movements in various trade channels that
include estimated trade inventory movements of PMI's competitors arising from
market-specific factors that significantly distort reported volume disclosures.
Such factors may include changes to the manufacturing supply chain, shipment
methods, consumer demand, timing of excise tax increases or other influences
that may affect the timing of sales to customers. In such instances, in addition
to reviewing PMI shipment volumes and certain estimated total industry/market
volumes on a reported basis, management reviews these measures on an adjusted
basis that excludes the impact of distributor and/or estimated trade inventory
movements. Management also believes that disclosing PMI shipment volumes and
estimated total industry/market volumes in such circumstances on a basis that
excludes the impact of distributor and/or estimated trade inventory movements,
such as on an IMS basis, improves the comparability of performance and trends
for these measures over different reporting periods.
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Key market data regarding total market size, our shipments and market share are
shown in the tables below:
For the Six Months Ended June 30,
PMI Shipments (billion units) PMI Market Share (%)(1)
Heated Heated
Total Market Tobacco Tobacco
Market (billion units) Total Cigarette Unit Total Unit
2020 2019 2020 2019 2020 2019 2020 2019 2020 2019 2020 2019
Total 1,224.1 1,325.0 343.8 374.7 308.4 348.1 35.4 26.6 27.7 28.1 2.9 2.1
European Union
France 18.2 18.9 8.5 8.6 8.4 8.6 0.1 - 44.7 44.9 0.4 0.2
Germany 36.0 34.3 14.5 13.4 13.7 13.0 0.8 0.4 40.4 38.9 2.2 1.1
Italy 32.0 32.8 17.1 17.0 14.6 15.6 2.5 1.4 52.0 51.4 7.5 4.2
Poland 21.4 22.9 8.5 9.2 7.6 8.8 0.9 0.4 39.7 40.4 4.3 1.9
Spain 20.0 21.8 6.4 7.5 6.2 7.3 0.2 0.1 31.1 31.4 1.0 0.6
Eastern Europe
Russia 104.1 106.3 32.9 29.9 26.7 27.2 6.2 2.7 32.4 29.1 6.2 3.0
Middle East & Africa
Saudi Arabia 10.3 10.6 3.8 4.7 3.8 4.7 - - 39.4 40.3 0.1 -
Turkey 55.9 61.6 21.8 26.4 21.8 26.4 - - 38.9 42.9 - -
South & Southeast Asia
Indonesia 131.4 145.2 38.5 47.1 38.5 47.1 - - 29.3 32.4 - -
East Asia &Australia Australia 5.1 6.0 1.5 1.7 1.5 1.7 - - 29.4 27.6 - - Japan 70.9 78.2 26.9 27.2 13.1 14.4 13.8 12.7 36.4 34.2 19.6 16.8 Korea 34.6 33.3 7.4 7.7 5.1 5.3 2.3 2.4 21.4 23.2 6.6 7.3
14.2 17.4 8.8 11.7 8.7 11.7 - - 61.6 67.0 0.2 -
(1) Market share estimates are calculated using IMS data Note: % change for Total Market and PMI shipments is computed based on millions of units; PMI Market Share estimates for previous periods are restated to reflect RBH deconsolidation and exclude RBH-owned brands.
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For the Three Months Ended June 30,
PMI Shipments (billion units) PMI Market Share (%)(1)
Total
Market Heated Heated
(billion Tobacco Tobacco
Market units) Total Cigarette Unit Total Unit
2020 2019 2020 2019 2020 2019 2020 2019 2020 2019 2020 2019
Total 609.2 700.3 170.1 198.9 151.4 183.8 18.7 15.1 28.0 28.1 3.0 2.1
European Union
France 9.8 9.8 4.5 4.5 4.4 4.5 - - 44.9 44.7 0.5 0.2
Germany 20.0 18.9 7.8 7.3 7.4 7.1 0.4 0.2 38.9 38.5 2.0 1.1
Italy 16.3 17.2 7.9 9.3 6.8 8.5 1.1 0.8 52.1 51.7 7.7 4.6
Poland 10.6 12.3 4.2 5.0 3.7 4.8 0.5 0.3 39.3 40.8 4.4 2.0
Spain 9.6 11.6 2.7 3.9 2.7 3.8 0.1 0.1 31.3 31.2 1.0 0.7
Eastern Europe
Russia 57.2 59.6 17.9 17.7 14.3 15.9 3.6 1.8 32.4 29.6 5.9 2.9
Middle East & Africa
Saudi Arabia 6.0 5.4 2.7 0.8 2.7 0.8 - - 38.6 38.9 0.2 -
Turkey 29.9 32.1 11.7 12.5 11.7 12.5 - - 38.9 38.9 - -
South & Southeast
Asia
Indonesia 64.0 77.6 18.0 24.9 18.0 24.9 - - 28.2 32.2 - -
Philippines 14.0 18.6 9.7 13.1 9.7 13.1 - - 69.5 70.6 - -
East Asia & Australia
Australia 2.6 2.9 0.8 0.9 0.8 0.9 - - 30.8 31.0 - -
Japan 35.4 40.6 14.1 15.1 6.3 8.0 7.8 7.1 36.5 34.0 20.0 16.6
Korea 18.4 17.7 3.8 4.1 2.6 2.8 1.2 1.3 21.1 23.1 6.6 7.3
Latin America & Canada
Argentina 7.3 7.8 4.8 5.6 4.8 5.6 - - 65.4 71.8 - -
Mexico 7.6 10.0 4.7 7.0 4.7 7.0 - - 62.1 69.5 0.2 -
(1) Market share estimates are calculated using IMS data Note: % change for Total Market and PMI shipments is computed based on millions of units; PMI Market Share estimates for previous periods are restated to reflect RBH deconsolidation and exclude RBH-owned brands.
Consolidated Operating Results for the Six Months Ended
The following discussion compares our consolidated operating results for the six
months ended
Our total shipment volume decreased by 8.2%, due to:
• the EU, reflecting lower cigarette shipment volume, notably in
and
the Region, particularly in
•
PMI Duty Free,
well as lower heated tobacco unit shipment volume in PMI Duty Free;
• South &
in
•
and
•
in
shipment volume in the Region decreased by 14.6%;
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partly offset by
•
the Region, notably in
shipment volume, notably in
Excluding the volume impact from the RBH deconsolidation of approximately 1.0
billion units (reflecting first quarter 2019 volume of RBH-owned brands and
including Duty-Free sales of these brands in
Impact of Inventory Movements
Excluding the volume impact from the deconsolidation of RBH, and the net favorable impact of estimated distributor inventory movements of approximately 3.0 billion units, our total in-market sales declined by 8.8%, due to an 11.8% decline in cigarettes, partly offset by a 29.5% increase in heated tobacco units.
The net favorable impact of estimated distributor inventory movements of approximately 3.0 billion units reflected:
• a net favorable impact of 2.2 billion cigarettes, mainly driven by
• a net favorable impact of 0.8 billion heated tobacco units, mainly driven by
Japan andRussia .
Our cigarette shipment volume by brand and heated tobacco units shipment volume are shown in the table below:
PMI Shipment Volume by Brand (Million Units)
Six Months Year-to-Date
2020 2019 Change
Cigarettes
Marlboro 114,057 128,024 (10.9 )%
L&M 45,025 45,337 (0.7 )%
Chesterfield 25,507 28,501 (10.5 )%
Philip Morris 22,569 23,673 (4.7 )%
Parliament 16,035 18,677 (14.1 )%
Sampoerna A 15,802 17,256 (8.4 )%
Bond Street 12,041 13,412 (10.2 )%
Dji Sam Soe 11,972 14,490 (17.4 )%
Lark 8,213 10,619 (22.7 )%
Fortune 4,745 6,487 (26.8 )%
Others 32,411 41,620 (22.1 )%
Total Cigarettes 308,377 348,096 (11.4 )%
Heated Tobacco Units (1) 35,435 26,554 33.4 %Total Cigarettes and Heated Tobacco Units 343,812 374,650 (8.2 )%
(1) Includes shipments to Altria Group, Inc., commencing in the third quarter of
2019, for sale in
Our cigarette shipment volume of the following brands decreased:
•
Free,
• L&M, notably due to PMI Duty Free,
• Chesterfield, notably due to
• Philip Morris, notably due to
the Philippines andRussia ; -59-
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•
• Sampoerna A in
•
• Dji Sam Soe in
• Lark, mainly due to
• Fortune in
• "Others," notably due to: the impact of the deconsolidation of RBH in
mid-price Sampoerna U in
Baronet in
The increase in our heated tobacco unit shipment volume was mainly driven by the
EU (notably
International Share of Market (excluding
Our total international market share (excludingChina andthe United States ), defined as our cigarette and heated tobacco unit sales volume as a percentage of total industry cigarette and heated tobacco unit sales volume, decreased by 0.4 points to 27.7%, reflecting: • Total international market share for cigarettes of 24.8%, down by 1.2 points;
and
• Total international market share for heated tobacco units of 2.9%, up by 0.8
points.
Our total international cigarette sales volume as a percentage of total industry cigarette sales volume was down by 0.9 points to 25.8%, mainly reflecting: out-switching to heated tobacco units, as well as lower cigarette market share and/or an unfavorable geographic mix impact, notably inIndonesia ,Mexico ,Pakistan ,the Philippines , PMI Duty Free andTurkey , partly offset byGermany andRussia . Financial Summary Financial Summary - Change Variance Six Months Ended June 30, Fav./(Unfav.) Fav./(Unfav.) 2020 2019 Total Excl. Total Cur- Price Vol/ Cost/ (in millions) Curr. rency Mix Other(1) Net Revenues$ 13,804 $ 14,450 (4.5 )% (1.8 )%$ (646 ) $ (391 ) $ 495 $ (523 ) $ (227 ) Cost of Sales (4,581 ) (5,130 ) 10.7 % 7.6 % 549 160 - 268 121 Marketing, Administration and Research Costs (2) (3,666 ) (4,048 ) 9.4 % 11.2 % 382 (70 ) - - 452 Amortization of (37 ) (35 ) (5.7 )% (8.6 )% (2 ) 1 - - (3 ) Intangibles Operating Income$ 5,520 $ 5,237 5.4 % 11.1 %$ 283 $ (300 ) $ 495 $ (255 ) $ 343 (1) Cost/Other variance includes the impact of the RBH deconsolidation. (2) Favorable Cost/Other variance includes the 2019 Canadian tobacco litigation-related expense of$194 million , the 2019 loss on deconsolidation of RBH of$239 million , the 2019 asset impairment and exit costs of$43 million and the 2020 asset impairment and exit costs of ($71 million ), as well as the impact of the RBH deconsolidation. Note: Net Revenues include revenues from shipments of the Platform 1 device, heated tobacco units and accessories to Altria Group, Inc., commencing in the third quarter of 2019, for sale under license inthe United States . For the six months endedJune 30, 2020 , net revenues, excluding unfavorable currency, decreased by 1.8%, reflecting: unfavorable volume/mix, primarily due to lower cigarette volume (mainly inAustralia ,Indonesia ,Italy ,Japan ,Mexico ,the Philippines , PMI Duty Free,Poland ,Spain andTurkey , partly offset byGermany ) and lower IQOS device volume (primarily inJapan ), partially offset by higher heated tobacco unit volume (notably in the EU,Japan ,Russia andUkraine , partly offset by PMI Duty Free); and the unfavorable impact of$227 million , shown in "Cost/Other," mainly resulting from the deconsolidation of RBH; partly offset by a favorable pricing variance (notably driven byAustralia , the GCC,Germany ,Mexico , andthe Philippines , partially offset byIndonesia ). -60-
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The unfavorable currency in net revenues was due primarily to the Euro, Indonesian rupiah, Mexican pesos, Russian ruble, and Turkish lira.
Net revenues include
Operating income, excluding unfavorable currency, increased by 11.1%, notably reflecting a favorable comparison, shown in "Cost/Other," of charges recorded in the first half of 2020 of$71 million , related to asset impairment and exit costs associated with organizational design optimization, to charges recorded in the first half of 2019 of$476 million , related to the loss on deconsolidation of RBH ($239 million ), the Canadian tobacco litigation-related expense ($194 million ), and asset impairment and exit costs ($43 million ) associated with plant closures inColombia andPakistan . Excluding these 2019 and 2020 charges, and unfavorable currency of$300 million , operating income increased by 3.1%, primarily reflecting: a favorable pricing variance; lower manufacturing costs (driven by productivity gains related to combustible and reduced-risk products); and lower marketing, administration and research costs (despite pandemic-related expenses in 2020); partially offset by unfavorable volume/mix, mainly due to lower cigarette volume (mainly inAustralia ,Indonesia ,Italy ,Japan ,Mexico ,the Philippines , PMI Duty Free,Poland andSpain , partly offset byGermany ), partly offset by higher heated tobacco unit volume (notably in the EU,Japan ,Russia andUkraine , partly offset by PMI Duty Free); and the net unfavorable impact resulting from the deconsolidation of RBH, included in "Cost/Other."
Interest expense, net, of
Our effective tax rate increased by 0.6 percentage points to 21.7%. The effective tax rate for the six months endedJune 30, 2020 was favorably impacted by a decrease in deferred tax liabilities related to the fair value adjustment of equity securities held by PMI ($16 million ) and a decrease in deferred tax liabilities related to the corporate income tax rate reduction inIndonesia ($30 million ). The effective tax rate for the six months endedJune 30, 2019 , was favorably impacted by the reversal of a deferred tax liability on the unremitted earnings of our Canadian subsidiary, RBH ($49 million ), a reduction of estimatedU.S. federal income tax on dividend repatriation for the years 2015-2018 ($67 million ) and by the Tax Cuts and Jobs Act. We estimate that our full-year 2020 effective tax rate will be approximately 22% to 23%, excluding the discrete tax events mentioned above. Changes in currency exchange rates, earnings mix by taxing jurisdiction or future regulatory developments may have an impact on the effective tax rates, which we monitor each quarter. Significant judgment is required in determining income tax provisions and in evaluating tax positions. For further details, see Note 9. Income Taxes. We are regularly examined by tax authorities around the world, and we are currently under examination in a number of jurisdictions. It is reasonably possible that within the next 12 months certain tax examinations will close, which could result in a change in unrecognized tax benefits along with related interest and penalties. An estimate of any possible change cannot be made at this time. Net earnings attributable to PMI of$3.8 billion increased by$100 million or 2.7%. This increase was due primarily to higher operating income as discussed above, partially offset by a higher effective tax rate. Diluted and basic EPS of$2.42 increased by 2.5%. Excluding an unfavorable currency impact of$0.19 , diluted EPS increased by 10.6%.
Consolidated Operating Results for the Three Months Ended
Our total shipment volume decreased by 14.5%, principally due to:
• the EU, reflecting lower cigarette shipment volume, notably in
and
most markets, notably
•
volume across the Region, notably in
•
particularly in
Free;
• South &
in Indonesia , Pakistan and the Philippines ;
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•
and
•
in
Impact of Inventory Movements
Excluding the net unfavorable impact of estimated distributor inventory movements of approximately 2.3 billion units, our total in-market sales declined by 13.4%, due to a 16.4% decline in cigarettes, partly offset by a 24.0% increase in heated tobacco units.
The net unfavorable impact of estimated distributor inventory movements of
approximately 2.3 billion units reflected a net unfavorable impact of 2.5
billion cigarettes, mainly due to
Our cigarette shipment volume by brand and heated tobacco units shipment volume are shown in the table below:
PMI Shipment Volume by Brand (Million Units)
Second-Quarter
2020 2019 Change
Cigarettes
Marlboro 54,812 68,060 (19.5 )%
L&M 22,385 23,522 (4.8 )%
Chesterfield 12,604 14,202 (11.3 )%
Philip Morris 11,106 12,950 (14.2 )%
Parliament 8,462 9,847 (14.1 )%
Sampoerna A 7,254 9,355 (22.5 )%
Bond Street 6,428 7,741 (17.0 )%
Dji Sam Soe 5,797 7,839 (26.0 )%
Lark 4,189 5,349 (21.7 )%
Fortune 2,263 3,441 (34.2 )%
Others 16,059 21,493 (25.3 )%
Total Cigarettes 151,359 183,799 (17.6 )%
Heated Tobacco Units (1) 18,708 15,056 24.3 %Total Cigarettes and Heated Tobacco Units 170,067 198,855 (14.5 )%
(1) Includes shipments to Altria Group, Inc., commencing in the third quarter of
2019, for sale in
Our cigarette shipment volume of the following brands decreased:
•
PMI Duty Free, partially offset by the GCC;
• L&M, mainly due to
by
• Chesterfield, mainly due to
by
• Philip Morris, primarily driven by
•
• Sampoerna A in
•
• Dji Sam Soe in
• Lark, mainly due to
• Fortune in
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• "Others," notably due to: mid-price Sampoerna U in
Morven in Pakistan .
The increase in our heated tobacco unit shipment volume was mainly driven by the
EU,
International Share of Market (excluding
Our total international market share (excludingChina andthe United States ), decreased by 0.1 point to 28.0%, reflecting: • Total international market share for cigarettes of 25.0%, down by 1.0 point;
and
• Total international market share for heated tobacco units of 3.0%, up by 0.9
points.
Our total international cigarette sales volume as a percentage of total industry cigarette sales volume was down by 0.7 points to 26.0%, mainly reflecting: out-switching to heated tobacco units, as well as lower cigarette market share and/or an unfavorable geographic mix impact, notably inIndonesia ,Mexico ,Pakistan ,the Philippines and PMI Duty Free, partly offset byGermany ,Russia andTurkey . Financial Summary Financial Summary - Change Variance Quarters Ended June 30, Fav./(Unfav.) Fav./(Unfav.) 2020 2019 Total Excl. Total Cur- Price Vol/ Cost/ (in millions) Curr. rency Mix Other Net Revenues$ 6,651 $ 7,699 (13.6 )% (9.5 )%$ (1,048 ) $ (317 ) $ 172 $ (904 ) $ 1 Cost of Sales (2,179 ) (2,665 ) 18.2 % 14.1 % 486 111 - 239 136 Marketing, Administration and Research Costs(1) (1,722 ) (1,831 ) 6.0 % 0.4 % 109 101 - - 8 Amortization of Intangibles (19 ) (16 ) (18.8 )% (25.0 )% (3 ) 1 - - (4 ) Operating Income$ 2,731 $ 3,187 (14.3 )% (11.0 )%$ (456 ) $ (104 ) $ 172 $ (665 ) $ 141 (1) Favorable Cost/Other variance includes the 2019 asset impairment and exit costs of$23 million and the 2020 asset impairment and exit costs of ($71 million ). Note: Net Revenues include revenues from shipments of Platform 1 devices, heated tobacco units and accessories to Altria Group, Inc., commencing in the third quarter of 2019, for sale under license inthe United States . For the three months endedJune 30, 2020 , net revenues, excluding unfavorable currency, decreased by 9.5%, mainly reflecting: unfavorable volume/mix, primarily due to lower cigarette volume (mainly inIndonesia ,Italy ,Japan ,Mexico ,the Philippines , PMI Duty Free andRussia , partly offset bySaudi Arabia ), partially offset by higher heated tobacco unit volume (notably in the EU,Japan andRussia , partly offset by PMI Duty Free); partially offset by a favorable pricing variance (notably driven byGermany ,Mexico ,the Philippines ,Russia andSaudi Arabia , partly offset byIndonesia andTurkey ).
The unfavorable currency in net revenues was due primarily to the Euro, Indonesian rupiah, Mexican pesos, Russian ruble, and Turkish lira.
Net revenues include$1,606 million in 2020 and$1,466 million in 2019 related to the sale of RRPs. IQOS devices accounted for approximately 8% of RRP net revenues in the second quarter of 2020 due to a lower ratio of new users to existing users given pandemic effects, longer replacement cycles and geographic mix. Operating income, excluding unfavorable currency, decreased by 11.0%, primarily reflecting: unfavorable volume/mix, due to the same factors as for net revenues noted above; partially offset by a favorable pricing variance; lower manufacturing costs (driven by productivity gains related to combustible and reduced-risk products); and lower marketing, administration and research costs (despite pandemic-related expenses in 2020 and the unfavorable net impact of asset impairment and exit costs).
Excluding higher asset impairment and exit costs of
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Interest expense, net, of
Our effective tax rate increased by 0.4 percentage points to 20.7%. The effective tax rate for the three months endedJune 30, 2020 was favorably impacted by a decrease in deferred tax liabilities related to the corporate income tax rate reduction inIndonesia ($30 million ). The effective income tax rate for the three months endedJune 30, 2019 was favorably impacted by a reduction of estimatedU.S. federal income tax on dividend repatriation for the years 2015-2018 ($67 million ) and by the Tax Cuts and Jobs Act. For further details, see Note 9. Income Taxes. Net earnings attributable to PMI of$1.9 billion decreased by$372 million or 16.0%. This decrease was due primarily to lower operating income as discussed above. Diluted and basic EPS of$1.25 decreased by 16.1%. Excluding an unfavorable currency impact of$0.06 , diluted EPS decreased by 12.1%.
Operating Results by Business Segment
Business Environment Taxes, Legislation, Regulation and Other Matters Regarding the Manufacture, Marketing, Sale and Use of Tobacco Products The tobacco industry and our company face a number of challenges that may adversely affect our business, volume, results of operations, cash flows and financial position. These challenges, which are discussed below and in "Cautionary Factors That May Affect Future Results," include:
• regulatory restrictions on our products, including restrictions on the
packaging, marketing, and sale of tobacco or other nicotine-containing
products that could reduce our competitiveness, eliminate our ability to
communicate with adult consumers, or even ban certain of our products;
• fiscal challenges, such as excessive excise tax increases and
discriminatory tax structures;
• illicit trade in cigarettes and other tobacco products, including
counterfeit, contraband and so-called "illicit whites";
• intense competition, including from non-tax paid volume by certain local
manufacturers;
• pending and threatened litigation as discussed in Note 8. Contingencies; and
• governmental investigations.
Regulatory Restrictions: The tobacco industry operates in a highly regulated environment. The well-known risks of smoking have led regulators to impose significant restrictions and high excise taxes on cigarettes.
We support a comprehensive regulatory framework for tobacco and nicotine-containing products based on the principle of harm reduction, including mandated health warnings, minimum age laws, restrictions on advertising, and public place smoking restrictions. We also support regulatory measures that help reduce illicit trade. Much of the regulation that shapes the business environment in which we operate is driven by theWorld Health Organization's ("WHO")Framework Convention on Tobacco Control ("FCTC"), which entered into force in 2005. The FCTC has as its main objective to establish a global agenda for tobacco regulation, with the purpose of reducing tobacco use. To date, 180 countries and theEuropean Union are Parties to the FCTC. The treaty requires Parties to have in place various tobacco control measures and recommends others. The FCTC governing body, the Conference of the Parties ("CoP"), has also adopted non-binding guidelines and policy recommendations related to certain articles of the FCTC that go beyond the text of the treaty. InOctober 2018 , the CoP recognized the need for more scientific assessment and improved reporting to define policy on heated tobacco products. Similar to its previous policy recommendations on e-cigarettes, the CoP invited countries to regulate, restrict or prohibit heated tobacco products, as appropriate under their national laws. InJuly 2019 , theWHO issued the Report on the Global Tobacco Epidemic 2019. While citing insufficient independent studies regarding the benefits and the unknown long-term health impacts of electronic nicotine delivery systems and heated tobacco products, theWHO has taken the position that such products are not risk-free and should be regulated in the same manner as cigarettes and in line with the FCTC provisions. It is not possible to predict whether or to what extent measures recommended by theWHO , including the FCTC guidelines, will be implemented. -64-
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We agree that all tobacco and nicotine-containing products, including our RRPs, need to be regulated; however, we continue to seek to engage in a dialogue with regulators with respect to those measures that we do not believe would protect public health and, if implemented, could disrupt competition, severely limit our ability to market and sell our products (including our RRPs) to adult smokers, or increase illicit trade. We advocate for measures that would accelerate switching to better alternatives to continued smoking and embrace a regulatory framework that recognizes a risk continuum of tobacco and other nicotine-containing products. Certain measures are discussed in more detail below and in the Reduced-Risk Products (RRPs) section. Fiscal Challenges: Excessive and disruptive excise, sales and other tax increases and discriminatory tax structures are expected to continue to have an adverse impact on our profitability, due to lower consumption and consumer down-trading to non-premium, discount, other low-price or low-taxed combustible tobacco products such as fine cut tobacco and illicit cigarettes. In addition, in certain jurisdictions, some of our combustible products are subject to tax structures that discriminate against premium-price products and manufactured cigarettes. We believe that such tax policies undermine public health by encouraging consumers to turn to illicit trade, and ultimately undercut government revenue objectives, disrupt the competitive environment, and encourage criminal activity. Other jurisdictions have imposed, or are seeking to impose, levies or other taxes specifically on tobacco companies, such as taxes on revenues and/or profits. EU Tobacco Products Directive: InApril 2014 , the EU adopted a significantly revised EU Tobacco Products Directive (TPD), which entered into force inMay 2016 . All Member States have adopted laws transposing the TPD. The TPD sets forth a comprehensive set of regulatory requirements for tobacco products, including:
• health warnings covering 65% of the front and back panels of cigarette
packs, with an option for Member States to further standardize tobacco
packaging, including the introduction of plain packaging;
• a ban on characterizing flavors in some tobacco products, with a
transition period for menthol that expired in May 2020 ;
• security features and tracking and tracing measures that became effective
on
• a framework for the regulation of novel tobacco products and e-cigarettes,
including requirements for health warnings and information leaflets, a
prohibition on product packaging text related to reduced risk, and theintroduction of notification requirements or authorization procedures in
advance of commercialization.
The EU Commission's Directorate General for Health and Food Safety is preparing a report on the implementation of the TPD, including the evaluation of whether the TPD has achieved its objectives and is still relevant considering scientific, international and technical developments, including in novel tobacco products and e-cigarettes. The report is expected to include recommendations on potential revisions of the TPD to account for such developments. The report is due byMay 2021 .Plain Packaging and Other Packaging Restrictions: Plain packaging legislation bans the use of branding, logos and colors on packaging other than the brand name and variant that may be printed only in specified locations and in a uniform font. To date, plain packaging laws have been adopted in certain markets in all of our operating segments, including the key markets ofAustralia ,France ,Saudi Arabia andTurkey . Some countries, such asCanada ,New Zealand andIsrael , adopted plain packaging regulations that apply to all tobacco products, including RRPs. Other countries are also considering plain packaging legislation. Some countries have adopted, or are considering adopting, packaging restrictions that could have an impact similar to plain packaging. Examples of such restrictions include standardizing the shape and size of packages, prohibiting certain colors or the use of certain descriptive phrases on packaging, and requiring very large graphic health warnings that leave little space for branding. Restrictions and Bans on the Use of Ingredients: TheWHO and others in the public health community have recommended restrictions or total bans on the use of some or all ingredients in tobacco products, including menthol. Broad restrictions and ingredient bans would require us to reformulate our American blend tobacco products and could reduce our ability to differentiate these products in the market in the long term. In many countries, menthol bans would eliminate the entire category of mentholated tobacco products. TheEuropean Union banned cigarettes and roll-your-own tobacco products with characterizing flavors. Other tobacco products, including heated tobacco products, are exempted from this flavor ban.The EU Commission is required to withdraw this exemption for a particular product category if it determines that there is a substantial change of circumstances, such as a significant increase of EU-wide sales volumes in such product category. It is not possible to predict how or when this determination would be made. Other countries may follow the EU's approach. For instance,Turkey banned menthol as ofMay 2020 . Broader ingredient bans have been adopted byCanada andBrazil . InBrazil , an ingredient ban is currently on appeal by a tobacco industry union, of which our Brazilian subsidiary is a member. It is not possible to predict the outcome of these legal proceedings. -65-
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Bans on Display of Tobacco Products at Retail: In a number of our markets,
including, but not limited to,
Bans and Restrictions on Advertising, Marketing, Promotions and Sponsorships: For many years, the FCTC has called for, and countries have imposed, partial or total bans on tobacco advertising, marketing, promotions and sponsorships, including bans and restrictions on advertising on radio and television, in print and on the Internet. The FCTC's non-binding guidelines recommend that governments prohibit all forms of communication with adult smokers. Restrictions on Product Design: Some members of the public health community are calling for the further standardization of tobacco products by requiring, for example, that cigarettes have a certain minimum diameter, which would amount to a ban on slim cigarettes, or requiring the use of standardized filter and cigarette paper designs. In addition, at its meeting inNovember 2016 , the CoP adopted non-binding guidelines recommending that countries regulate product design features that increase the attractiveness of tobacco products, such as the diameter of cigarettes and the use of flavor capsules. Restrictions on Public Smoking: The pace and scope of public smoking restrictions have increased significantly in most of our markets. Many countries around the world have adopted, or are likely to adopt, regulations that restrict or ban smoking in public and/or work places, restaurants, bars and nightclubs. Some public health groups have called for, and some countries, regional governments and municipalities have adopted or proposed, bans on smoking in outdoor places, as well as bans on smoking in cars (typically, when minors are present) and private homes. Other Regulatory Issues: Some regulators are considering, or in some cases have adopted, regulatory measures designed to reduce the supply of tobacco products. These include regulations intended to reduce the number of retailers selling tobacco products by, for example, reducing the overall number of tobacco retail licenses available or banning the sale of tobacco products within specified distances of certain public facilities. In addition, recently,South Africa banned the sale of tobacco products, e-cigarettes and electronic devices that heat tobacco during the COVID-19 pandemic; the ban resulted in a significant increase of illicit trade of tobacco products.
In a limited number of markets, most notably
The EU Single-Use Plastics Directive, which will require tobacco manufacturers and importers to cover the costs of public collection systems for tobacco product filters, entered into force onJuly 2, 2019 , after which Member States will have two years to transpose it into national law. While we cannot predict the impact of this initiative on our business at this time, we are monitoring developments in this area. Illicit Trade: Illicit tobacco trade creates a cheap and unregulated supply of tobacco products, undermines efforts to reduce smoking prevalence, especially among youth, damages legitimate businesses and intellectual property rights, stimulates organized crime, increases corruption and reduces government tax revenue. Without accounting for any potential COVID-19-related impact, we generally estimate that, excludingChina and theU.S. , illicit trade may account for as much as 10 to 12% of global cigarette consumption; this includes counterfeit, contraband and the persistent problem of "illicit whites," which are cigarettes legally produced in one jurisdiction for the sole purpose of being exported and illegally sold in another jurisdiction where they have no legitimate market. Currently, we estimate that illicit trade in theEuropean Union accounted for approximately 8% of total cigarette consumption in 2019. A number of jurisdictions are considering actions to prevent illicit trade. InNovember 2012 , the FCTC adopted the Protocol to Eliminate Illicit Trade in Tobacco Products (the "Protocol"), which includes supply chain control measures, such as licensing of manufacturers and distributors, enforcement of these control measures in free trade zones, controls on duty free and Internet channels and the implementation of tracking and tracing technologies. To date, 60 Parties, including theEuropean Union , have ratified it. The Protocol came into force inSeptember 2018 . Parties must now start implementing its provisions in their national legislation. InOctober 2018 , the first Meeting of the Parties to the Protocol decided to produce a comprehensive report on good practices for the implementation of tracking and tracing systems and to prepare a conceptual framework for global information sharing to combat illicit tobacco trade. We welcome this decision and expect that other Parties will ratify the Protocol. We devote substantial resources to help prevent illicit trade in combustible tobacco products and RRPs. For example, we engage with governments, our business partners and other stakeholders to implement effective measures to combat illicit trade and, in some instances, pursue legal remedies to protect our intellectual property rights. -66-
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The tracking and tracing regulations for cigarettes and roll-your-own products manufactured or destined for the EU became effective onMay 20, 2019 . The effective date for other tobacco-containing products, including some of our RRPs such as heated tobacco units, isMay 20, 2024 . While we expect that this regulation will increase our operating expenses, we do not expect this increase to be significant. In 2009, our Colombian subsidiaries entered into an Investment and Cooperation Agreement with the national and regional governments ofColombia to promote investment in, and cooperation on, anti-contraband and anti-counterfeit efforts. The agreement provides$200 million in funding over a 20-year period to address issues such as combating illegal cigarette trade and increasing the quality and quantity of locally-grown tobacco. InMay 2016 , PMI launched PMI IMPACT, a global initiative that supports third-party projects dedicated to fighting illegal trade and related crimes such as corruption, organized criminal networks and money laundering. The centerpiece of PMI IMPACT is a council of external independent experts in the fields of law, anti-corruption and law enforcement. The experts are responsible for evaluating and approving funding proposals for PMI IMPACT grants. PMI has pledged$100 million to fund projects within PMI IMPACT over three funding rounds.
Reduced-Risk Products (RRPs)
Our Approach to RRPs: We recognize that smoking cigarettes causes serious
diseases and that the best way to avoid the harms of smoking is never to start
or to quit. Nevertheless, it is predicted that over the next decade the number
of smokers will remain largely unchanged from the current estimate of 1.1
billion, despite the considerable efforts to discourage smoking.
Cigarettes burn tobacco, which produces smoke. As a result of the combustion
process, the smoker inhales various toxic substances. In contrast, RRPs do not
burn tobacco and produce an aerosol that contains significantly lower levels of
harmful and potentially harmful constituents ("HPHCs") than found in cigarette
smoke.
For adult smokers who would otherwise continue to smoke, we believe that RRPs,
while not risk-free, offer a much better consumer choice. Accordingly, our key
strategic priorities are: to develop and commercialize products that present
less risk of harm to adult smokers who switch to those products versus continued
smoking; and to convince current adult smokers who would otherwise continue to
smoke to switch to those products.
We recognize that this transformation from cigarettes to RRPs will take time and
that the speed of transformation will depend in part upon factors beyond our
control, such as the willingness of governments, regulators and other policy
groups to embrace RRPs as a desired alternative to continued cigarette smoking.
We also recognize that our part in this transformation must be funded from our
existing cigarette business. For as long as a significant number of adult
smokers continues to smoke, it is critical that the industry be led by
responsible and ethical manufacturers. Therefore, during the transformation, we
intend to remain a leading international cigarette manufacturer.
We have a range of RRPs in various stages of development, scientific assessment
and commercialization. We conduct rigorous scientific assessments of our RRP
platforms to substantiate that they reduce exposure to HPHCs and, ultimately,
that these products present, are likely to present, or have the potential to
present less risk of harm to adult smokers who switch to them versus continued
smoking. We draw upon a team of expert scientists and engineers from a broad
spectrum of scientific disciplines and our extensive learnings of adult consumer
preferences to develop and assess our RRPs. Our efforts are guided by the
following key objectives:
• to develop RRPs that adult smokers who would otherwise continue to smoke
find to be satisfying alternatives to smoking;
• for those adult smokers, our goal is to offer RRPs with a scientifically
substantiated risk-reduction profile that approaches as closely as
possible that associated with smoking cessation;
• to substantiate the reduction of risk for the individual adult smoker and
the reduction of harm to the population as a whole, based on scientific
evidence of the highest standard that is made available for scrutiny and
review by external independent scientists and relevant regulatory bodies;
and
• to advocate for the development of science-based regulatory frameworks for
the development and commercialization of RRPs, including the communication
of scientifically substantiated information to enable adult smokers to
make better consumer choices.
Our RRP Platforms: Our product development is based on the elimination of
combustion via tobacco heating and other innovative systems for aerosol
generation, which we believe is the most promising path to providing a better
consumer choice for those
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would otherwise continue to smoke. We recognize that no single product will appeal to all adult smokers. Therefore, we are developing a portfolio of products intended to appeal to a variety of distinct adult consumer preferences.
Four RRP platforms are in various stages of development and commercialization readiness:
Platform 1 uses a precisely controlled heating device incorporating our IQOS
HeatControl technology, into which a specially designed and proprietary tobacco
unit is inserted and heated to generate an aerosol. We have conducted a series
of clinical studies for this platform, the results of which were included in our
submission to the U.S. Food and Drug Administration ("FDA") described below. We
completed a 6+6 month exposure response study and shared the results with the
FDA in April 2020 . The study showed that for the group that switched to our
Platform 1 product, the eight clinical risk endpoints that were tested as
co-primary endpoints in the first six-month term moved in the same direction as
observed for smoking cessation after 12 months of use of this product. In
addition, we completed an 18-month combined chronic toxicity and carcinogenicity
study in mice, which was on-going at the time of our FDA submission. We shared
the results with the FDA in August 2018 .
Platform 2 uses a pressed carbon heat source which, when ignited, generates a
nicotine-containing aerosol by heating tobacco. The results of our
pharmacokinetic study (that measured the nicotine pharmacokinetic profile as
well as subjective effects) and of our five-day reduced exposure study indicate
that this platform could be an acceptable substitute for adult smokers who seek
an alternative to cigarettes. The reduced exposure study results showed a
substantial reduction in relevant biomarkers of exposure to the measured HPHCs
in those who switched to Platform 2 compared to those who continued to smoke
cigarettes over a five-day period. The sustainability of this reduction as well
as changes in clinical risk markers were assessed in a three-month reduced
exposure study. The results of this study were received at the end of 2017, and
the related report was finalized in the second quarter of 2018.
Platform 3 provides an aerosol of nicotine salt. We have explored two routes
for this platform, one with electronics and one without, and conducted nicotine
pharmacokinetic studies with both versions. The results of the pharmacokinetic
study related to the version without electronics were received, and the related
report was finalized in the fourth quarter of 2018. The results indicate this
product's potential as an acceptable alternative to continued cigarette smoking
in terms of product satisfaction. In February 2020 , we completed a product use
and adaptation study in adult smokers for the product variant without
electronics. The analysis was completed and the related report finalized in the
second quarter of 2020.
Platform 4 covers e-vapor products, which are battery-powered devices that
produce an aerosol by vaporizing a nicotine-containing liquid solution. Our
e-vapor products comprise devices using current generation technology and our
new e-vapor mesh technology that addresses certain challenges presented by some
e-vapor products currently on the market. Our IQOS MESH products are designed to
ensure the consistency and quality of the generated aerosol. We conducted a
nicotine pharmacokinetic study in 2017. The results of this study were received
in the second quarter of 2018 for analysis, and the related report was finalized
in the fourth quarter of 2018. The results of this study indicate that IQOS MESH
products are an effective means of nicotine delivery while being a satisfying
alternative for e-cigarette users. In March 2019 , a six-month pre-clinical study
in mice evaluating the impact of e-cigarette vapor on the risks of pulmonary and
cardiovascular disease compared to cigarette smoke was completed; this study did
not pertain to a specific product. The study demonstrated that e-cigarette
vapors induce significantly lower biological responses associated with
cardiovascular and pulmonary diseases compared with cigarette smoke. We will
also initiate a clinical study to measure selected biomarkers of exposure to
HPHCs and assess changes in clinical risk markers.
After we receive the results of our scientific studies mentioned above, in accordance with standard scientific practices, we intend to share the conclusions in scientific forums and to submit them for inclusion in peer-reviewed publications.
Commercialization of RRPs: We are building a new product category and tailor our commercialization strategy to the characteristics of each specific market. We focus our commercialization efforts on consumer retail experience, guided consumer trials and customer care, and increasingly, digital communication programs. In order to accelerate switching to our Platform 1 product, our initial market introductions typically entail one-on-one consumer engagement and introductory device discounts. These initial commercialization efforts require substantial investment, which we believe will moderate over time. In 2014, we introduced our Platform 1 product in pilot city launches inNagoya, Japan , and inMilan, Italy . Since then, we have continuously expanded our commercialization activities, and the product has been commercialized in 57 markets in key cities or nationwide. While our Platform 1 products are currently available for sale inMexico , that country recently banned the importation of e-cigarettes and devices that heat tobacco. The sale of our Platform 1 product is temporarily suspended inSouth Africa due to the pandemic-related ban on such products.
We estimate that only a very small percentage of adult smokers
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We have integrated the production of our heated tobacco units into a number of our existing manufacturing facilities, are progressing with our plans to build manufacturing capacity for our other RRP platforms, and continue to optimize our manufacturing infrastructure. An adequate supply chain for our RRP portfolio, including the supply of electronic devices, is important to our business. We work with two electronics manufacturing service providers for the supply of our Platform 1 and IQOS MESH devices and a small number of other providers for other products in our RRP portfolio and related accessories. Due to the COVID-19 pandemic, the operations of our two electronic manufacturing service providers were temporarily suspended at different times. Even though these suspensions did not materially affect our operations, if both of these service providers were significantly constrained at the same time, the supply of the devices could be disrupted. Although we work closely with these service providers on monitoring their production capability and financial health, we cannot guarantee that they will remain capable of meeting their commitments, particularly during the COVID-19 pandemic; if they will not, the commercialization of our RRPs could be adversely affected. The production of our RRP portfolio requires various metals, and we believe that there is an adequate supply of such metals in the world markets to satisfy our current and anticipated production requirements. However, some components and materials necessary for the production of our RRPs, including those for the electronic devices, are obtained from single or limited sources, and can be subject to industry-wide shortages and price fluctuations. While we were successful in maintaining adequate supply of such components and materials so far, we may not be able to secure such supply going forward, particularly during the COVID-19 pandemic; this could negatively impact the commercialization of our RRPs. For details on the impact of COVID-19 on our production and supply chain, see the "Executive Summary" section of this MD&A. Our Platform 1 and IQOS MESH devices are subject to standard product warranties generally for a period of 12 months from the date of purchase or such other periods as required by law. We discuss product warranties in more detail in Note 16. Product Warranty. The significance of warranty claims is dependent on a number of factors, including device version mix, product failure rates, logistics and service delivery costs, and warranty policies, and may increase with the number of devices sold.
Product quality may affect consumer acceptance of our RRPs.
Our commercialization efforts for the other RRP platforms are as follows:
• In light of the confusion in the e-vapor category, in
postponed our planned launch of an improved version of our IQOS MESH
product and currently plan to launch these products under the IQOS VEEV or
VEEV brand names in select markets in the second half of 2020.
• With respect to TEEPS, our Platform 2 product, we are finalizing our
improvements to this product and plan to conduct a consumer test in the
beginning of 2021.
• We plan to conduct a consumer test of our Platform 3 product by the end of
2020.
Due to the COVID-19 pandemic, these plans may be delayed.
RRP Regulation and Taxation: RRPs contain nicotine and are not risk-free. We therefore support science-based regulation and taxation of RRPs. Regulation and taxation should differentiate between cigarettes and products that present, are likely to present, or have the potential to present less risk of harm to adult smokerswho switch to these products versus continued smoking and should recognize a continuum of risk for tobacco and other nicotine-containing products. Regulation should provide minimum standards for all RRP categories and specific rules for product assessment methodologies, ingredients, labeling and consumer communication, and should ensure that the public is informed about the health risks of all combustible and non-combustible tobacco and nicotine-containing products. Regulation, as well as industry practices, should reflect the fact that youth should not consume nicotine in any form. Some governments have banned or are seeking to ban or severely restrict emerging tobacco and nicotine-containing products such as our RRPs and communication of truthful and non-misleading information about such products. For example, the commercialization of e-cigarettes and heat-not-burn products is prohibited inAustralia , the commercialization of e-cigarettes is prohibited inArgentina , the importation of e-cigarettes and heat-not-burn products is prohibited inTurkey , and the importation of e-cigarettes and devices that heat tobacco is prohibited inMexico . These regulations might foreclose or unreasonably restrict adult consumer access even to products that might be shown to be a better consumer choice than continuing to smoke. During the COVID-19 pandemic, governments may temporarily be unable to -69-
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focus on the development of science-based regulatory frameworks for the development and commercialization of RRPs or on the enforcement or implementation of regulations that are significant to our business.
We oppose blanket bans and unreasonable restrictions of products that have the potential to present less risk of harm compared to continued smoking. By contrast, we support regulation that sets clear standards for all RRP categories and propels innovation to benefit adult smokerswho would otherwise continue to smoke. Inthe United States , an established regulatory framework for assessing "Modified Risk Tobacco Products" and "New Tobacco Products" exists under the jurisdiction of the FDA. We submitted to the FDA a Modified Risk Tobacco Product Application ("MRTPA") for our Platform 1 product inDecember 2016 , and a Premarket Tobacco Product Application ("PMTA") for our Platform 1 product inMarch 2017 . OnApril 30, 2019 , the FDA determined that a version of our Platform 1 product is appropriate for the protection of public health and authorized it for sale inthe United States . TheFDA's decision followed its comprehensive assessment of our PMTA. We filed a supplemental PMTA application for the IQOS 3 device inMarch 2020 . OnJuly 7, 2020 , the FDA determined that the available scientific evidence demonstrates that the issuance of an exposure modification order would be appropriate for the promotion of public health and authorized the marketing of a version of our Platform 1 product as a "modified risk tobacco product." The FDA authorized the marketing of this product in theU.S. with the following information:
"AVAILABLE EVIDENCE TO DATE:
•the IQOS system heats tobacco but does not burn it. •this significantly reduces the production of harmful and potentially harmful chemicals. •scientific studies have shown that switching completely from conventional cigarettes to the IQOS system significantly reduces your body's exposure to harmful or potentially harmful chemicals."
We must request and receive authorization from the FDA in order to continue marketing this product with the same modified exposure information after the present order expires in four years.
There are two types of MRTP orders the FDA may issue: a "risk modification" order or an "exposure modification" order. We had requested both types of orders for our Platform 1 product. After review, the FDA determined that the evidence did not support issuing a "risk modification" order at this time but that it did support issuing an "exposure modification" order for the product. This determination included a finding that issuance of the exposure modification order is expected to benefit the health of the population as a whole.
We look forward to working with the FDA to provide any additional information they may require in order to market this product with reduced risk claims.
TheFDA's PMTA and MRTP orders do not mean that the agency "approved" our Platform 1 product. Both authorizations are subject to strict marketing, reporting and other requirements and are not a guarantee that the product will remain authorized, particularly if there is a significant uptake in youth or non-smoker initiation. The FDA will monitor the marketing of the product.
In
In theU.S. , tobacco and nicotine-containing products that were not commercially marketed as ofFebruary 15, 2007 are subject to review and authorization by the FDA. Manufacturers of all non-authorized products currently on the market are required to file a PMTA with the FDA byMay 12, 2020 . InApril 2020 , theU.S. District Court allowed the FDA to extend the filing date by 120 days given the COVID-19 pandemic. OnJanuary 2, 2020 , the FDA announced an enforcement policy against the sale of e-vapor products sold without FDA authorization, prioritizing enforcement against the sale of cartridge-based e-vapor products with flavors other than tobacco and menthol, and sale of any nicotine-containing products to minors and where the manufacturer fails to take adequate measures to prevent access by minors. The FDA indicated that the enforcement policy will be amended to reflect the PMTA deadline extension mentioned above. -70-
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While we do not sell e-vapor products in theU.S. and therefore are not subject to these actions, we continue to support regulation and industry practices that reflect the fact that youth should not consume nicotine in any form.
FDA actions may influence the regulatory approach of other governments.
Until recently, there were no countries with specific product standards for heat-not-burn products. Currently, national standards setting minimum quality and safety requirements for heat-not-burn products have been adopted with defined methods for demonstrating the absence of combustion in several countries; they are mandatory inEgypt ,Jordan and theUAE , and voluntary in theU.K. ,Russia ,Ukraine ,Kazakhstan , andKyrgyzstan . We expect other governments to consider similar product standards and encourage making them mandatory. In the EU, all EU Member States have transposed the EU Tobacco Products Directive, including the provisions on novel tobacco products, such as heated tobacco units, and e-cigarettes. Most of the EU Member States require a notification submitted six months before the intended placing on the market of a novel tobacco product, while some require pre-market authorizations for the introduction of such products. To date, we have filed a comprehensive dossier summarizing our scientific assessment of our Platform 1 product in over 20 Member States. In addition, inItaly , inApril 2018 , we submitted an application for HEETS, used with the IQOS device, requesting regulatory recognition of the reduction of toxic substances and potential risk reduction resulting from switching to this product compared to continued cigarette smoking. InJanuary 2019 , our application was not granted primarily on the grounds of insufficient data and questions of methodology. Due to the constraints of the review process, we had been unable to supplement the application with all the data we subsequently filed with the FDA and to address methodological questions during the review. We plan to submit a new application where we will clarify the concerns raised by the decision and further strengthen our application by submitting additional evidence that became available since we submitted our first application, consistent with our FDA filing. We are confident that our evidence supports our application. OnOctober 31, 2019 , our Australian subsidiary, Philip Morris Limited ("PML"), submitted an application to theScheduling Committee of theTherapeutic Goods Administration of Australia ("TGA") seeking to exempt heated tobacco products from being prohibited inAustralia . InJune 2020 , the TGA issued an interim decision denying the application and stating that it has not identified compelling evidence to establish a public health benefit from greater access to nicotine in heated tobacco products. PML disagrees with the interim decision and has requested its reconsideration. We expect that following a review of comments submitted during the public comment period the TGA would issue its final decision in the next few months.
To date, several governmental agencies have published their scientific findings that analyze the harm-reduction potential of certain RRPs versus continuing smoking, including:
InDecember 2017 , at the request of theU.K. Department of Health andPublic Health England , theU.K. Committee on Toxicity published its assessment of the risk of heat-not-burn products relative to cigarette smoking. This assessment included analysis of scientific data for two heat-not-burn products, one of which was our Platform 1 product. The assessment concluded that, while still harmful to health, compared with the known risks from cigarettes, heat-not-burn products are probably less harmful. Subsequently, inFebruary 2018 ,Public Health England published a report stating that the available evidence suggests that heat-not-burn products may be considerably less harmful than cigarettes and more harmful than e-cigarettes. InMay 2018 , theGerman Federal Institute for Risk Assessment ("BfR") published a study on the Platform 1 aerosol relative to cigarette smoke using the Health Canada Intense Smoking Regimen. BfR found reductions in selected HPHCs in a range of 80-99%. This publication indicates that significant reductions in the levels of selected toxicants are likely to reduce toxicant exposure, which BfR stated might be regarded as a discrete benefit compared to combustible cigarettes. InMay 2018 , theDutch National Institute for Public Health and Environment ("RIVM") published a factsheet on novel tobacco products that heat rather than burn tobacco, focusing on our Platform 1 product. RIVM analyzed the aerosol generated by our Platform 1 product and concluded that the use of this product, while still harmful to health, is probably less harmful than continued smoking. InJune 2018 , theKorean Food and Drug Administration ("KFDA") issued a statement on products that heat rather than burn tobacco. The KFDA tested three heat-not-burn products, one of which was our Platform 1 product. The KFDA confirmed that the levels of the nine HPHCs tested in the aerosol of these products were on average approximately 90% lower compared to those measured in the cigarette smoke of the top five cigarette brands inSouth Korea . However, the KFDA stated that it could not establish that the tested heat-not-burn products are less harmful than cigarettes. InOctober 2018 , our Korean subsidiary filed a -71-
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request with a local court seeking information underlying KFDA's analysis,
conclusions and public statements. In
InAugust 2018 , theScience & Technology Committee of theU.K. House of Commons published a report of its inquiry into e-cigarettes and heat-not-burn products. The report concluded that e-cigarettes are significantly less harmful to health than smoking tobacco. The report also observed that for those smokerswho don't accept e-cigarettes, heat-not-burn products may offer a public health benefit despite their relative risk. The report called for a risk-proportionate regulatory environment for both e-cigarettes and heat-not-burn products and noted that e-cigarettes should remain the least taxed, cigarettes the most taxed, with heat-not-burn products falling between the two.The U.K. Committee on Advertising Practice announced the removal of a prohibition of health claims in the advertising of e-cigarettes in theU.K. effectiveNovember 2018 .
In
InJanuary 2019 , scientific media published the results of the study of the China National Tobacco Quality Supervision and Test Centre ("CNTQST") comparing the aerosol generated by our Platform 1 product with cigarette smoke. The CNTQST found that the former contained fewer, and lower levels of, harmful constituents than the latter and concluded that the lower temperature of heating tobacco in our Platform 1 product contributed to the difference. The CNTQST stated that the reduction in emissions of harmful constituents cannot be interpreted as equivalent to a proportionate harm/risk reduction for smokers. We make our scientific findings publicly available for scrutiny and peer review through several channels, including our websites. From time to time, adult consumers, competitors, members of the scientific community, and others inquire into our scientific methodologies, challenge our scientific conclusions or request further study of certain aspects of our RRPs and their health effects. We are committed to a robust and open scientific debate and believe that such debate should be based on accurate and reliable scientific information. We seek to provide accurate and reliable scientific information about our RRPs; nonetheless, we may not be able to prevent third-party dissemination of false, misleading or unsubstantiated information about these products. The dissemination of scientifically unsubstantiated information or studies with a strong confirmation bias by third parties may cause confusion among adult smokers and affect their decision to switch to better alternatives to continued smoking, such as our RRPs. To date, we have been largely successful in demonstrating to regulators that our heated tobacco units are not cigarettes due to the absence of combustion, and as such they are generally taxed either as a separate category or as other tobacco products, which typically yields more favorable tax rates than cigarettes. Although we believe that this is sensible from the public health perspective, we cannot guarantee that regulators will continue this approach.
There can be no assurance that we will succeed in our efforts to replace cigarettes with RRPs or that regulation will allow us to commercialize RRPs in all markets, to communicate about our RRPs, including making scientifically substantiated risk-reduction claims, or to treat RRPs differently from cigarettes.
Legal Challenges to RRPs: We face various administrative and legal challenges related to certain RRP activities, including allegations concerning product classification, advertising restrictions, corporate communications, product coach activities, scientific substantiation, product liability, and unfair competition. While we design our programs to comply with relevant regulations, we expect these or similar challenges to continue as we expand our efforts to commercialize RRPs and to communicate publicly. The outcomes of these matters may affect our RRP commercialization and public communication activities and performance in one or more markets. Our RRP Business Development Initiatives: InDecember 2013 , we established a strategic framework with Altria Group, Inc. ("Altria") setting out terms on how the parties would collaborate to develop and commercialize e-vapor products and commercialize two of our RRPs in theU.S. In late 2018, Altria announced that it will participate in the e-vapor category only through another e-vapor company in which Altria acquired a minority interest. InSeptember 2019 , Altria's subsidiary,Philip Morris USA Inc. ("PM USA "), began commercialization of a version of our Platform 1 product in theU.S. PM USA is responsible for the marketing of this product in theU.S. and implementation of the messages authorized by the FDA in its MRTP order described above. InJanuary 2020 , we announced an agreement with KT&G, a leading tobacco and nicotine company inSouth Korea , for the commercialization of KT&G's smoke-free products outside ofSouth Korea on an exclusive basis. For more information, see Acquisitions and Other Business Arrangements below. -72-
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Other Developments: InSeptember 2017 , we announced our support of theFoundation for a Smoke-Free World . We agreed to contribute$80 million per year over the next 12 years, as specified in the agreement. To date, we contributed a total of$164.5 million . The Foundation is an independent body and is governed by its independent Board of Directors. The Foundation's role, as set out in its corporate charter, includes funding research in the field of tobacco harm reduction, encouraging measures that reduce the harm caused by smoking, and assessing the effect of reduced cigarette consumption on the industry value chain. Governmental Investigations From time to time, we are subject to governmental investigations on a range of matters, including tax, customs, antitrust, advertising, and labor practices. We describe certain matters pending inThailand ,Russia andSouth Korea in Note 8. Contingencies. InNovember 2010 , aWTO panel issued its decision in a dispute relating to facts that arose fromAugust 2006 betweenthe Philippines andThailand concerning a series of Thai customs and tax measures affecting cigarettes imported by PMThailand intoThailand (see Note 8. Contingencies for additional information). TheWTO panel decision, which was upheld by the WTO Appellate Body, concluded thatThailand had no basis to find that PM Thailand's declared customs values and taxes paid were too low, as alleged by the DSI in 2009. The decision also created obligations forThailand to revise its laws, regulations, or practices affecting the customs valuation and tax treatment of future cigarette imports.Thailand agreed inSeptember 2011 to fully comply with the decision byOctober 2012 .The Philippines asserts that to dateThailand has not fully complied with theWTO panel decision and commenced challenges at the WTO Appellate Body. The WTO Appellate Body is not operational, and the appeals byThailand are suspended indefinitely. It is not possible to predict any future developments in these proceedings. The Public Prosecutor's office ofRome, Italy , notified our Italian subsidiary, Philip Morris Italia S.r.l. ("PM Italia"), as well as three former or current employees and a former external consultant of PM Italia in July andMarch 2020 , respectively, that it has concluded a preliminary investigation against them for alleged contravention of anti-corruption laws. The Public Prosecutor alleges that the individuals involved promised certain personal favors to government officials from January to July of 2018 in exchange for favorable treatment for PM Italia, and that PM Italia lacked appropriate organizational controls to prevent the alleged actions by the individuals. The defendants are presenting their defenses to the Public Prosecutorwho will decide whether to proceed with the charges towards a trial or to dismiss all or some of them. PM Italia is cooperating with the Public Prosecutor and is currently reviewing the evidentiary materials recently provided by the Public Prosecutor.
Asset Impairment and Exit Costs
We discuss asset impairment and exit costs in Note 18. Asset Impairment and Exit Costs to our condensed consolidated financial statements.
Acquisitions and Other Business Arrangements
InJanuary 2020 , PMI announced a global collaboration agreement with the leading tobacco and nicotine company inSouth Korea , KT&G, to commercialize KT&G's smoke-free products outside of the country. The agreement will run for an initial period of three years. The two companies plan for global collaboration with the intention to actively expand to cover many markets, based on commercial success. The agreement allows PMI to distribute current KT&G smoke-free products, and their evolutions, on an exclusive basis, and does not restrict PMI from distributing its own or third-party products. KT&G's smoke-free product brand portfolio includes heat-not-burn tobacco products (e.g.,Lil Mini and Lil Plus), hybrid technologies that combine heat-not-burn tobacco and e-vapor technologies (e.g., Lil Hybrid), and e-vapor products (e.g., Lil Vapor). PMI will be responsible for the commercialization of smoke-free products supplied under the agreement. Products sold under the agreement will be subject to careful assessment to ensure they meet the regulatory requirements in the markets where they are launched, as well as our standards of quality and scientific substantiation of their harm reduction potential. PMI and KT&G will seek any necessary regulatory approvals that may be required on a market-by-market basis. There are no current plans to commercialize KT&G products inthe United States .
We currently plan to launch our commercial initiatives for the licensed KT&G products in select markets in the second half of 2020.
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Investments in
We discuss our investments in unconsolidated subsidiaries and equity securities in Note 11. Fair Value Measurements and Note 14. Related Parties - Investments in Unconsolidated Subsidiaries,Equity Securities and Other to our condensed consolidated financial statements.
We are subject to various trade restrictions imposed bythe United States of America and countries in which we do business ("Trade Sanctions"), including the trade and economic sanctions administered by theU.S. Department of the Treasury's Office of Foreign Assets Control and theU.S. Department of State . It is our policy to comply fully with these Trade Sanctions.
Tobacco products are agricultural products under
A subsidiary sells products to distributors that, in turn, sell those products to duty free customers that supplyU.N . peacekeeping forces around the world, including those in theU.N . peacekeeping mission located in Abyei, a special administrative territory inSudan . We do not believe that these sales, which are not subject to Trade Sanctions, and are de minimis in volume and value, present a material risk to our shareholders, our reputation or the value of our shares. We have no employees, operations or assets inSudan . We do not sell products inIran ,North Korea andSyria . From time to time, we explore opportunities to sell our products in one or more of these countries, as permitted by law. Certain states within theU.S. have enacted legislation permitting or requiring state pension funds to divest or abstain from future investment in stocks of companies that do business with certain countries that are sanctioned by theU.S. We do not believe such legislation has had a material effect on the price of our shares.
Operating Results - Three Months and Six Months Ended
The following discussion compares operating results within each of our operating segments for the three months and six months endedJune 30, 2020 , with the three months and six months endedJune 30, 2019 . Unless otherwise stated, references to total industry, total market, our shipment volume and our market share performance reflect cigarettes and heated tobacco units.European Union : Change Variance Financial Summary - Fav./(Unfav.) Fav./(Unfav.) Quarters Ended June 30, Excl. Cur- Vol/ Cost/ (in millions) 2020 2019 Total Curr. Total rency Price Mix Other Net Revenues$ 2,475 $ 2,577 (4.0 )% (0.1 )%$ (102 ) $ (100 ) $ 44 $ (46 ) $ - Operating Income$ 1,178 $ 1,195 (1.4 )% 4.0 %$ (17 ) $ (65 ) $ 44 $ (2 ) $ 6 For the three months endedJune 30, 2020 , the effects of the COVID-19 pandemic impacted our net revenues. Net revenues, excluding unfavorable currency, decreased by 0.1%, reflecting: unfavorable volume/mix, mainly due to lower cigarette volume (notably inItaly ,Poland andSpain , partly offset byGermany ), partially offset by higher heated tobacco unit volume (notably inGermany ,Italy andPoland ); largely offset by a favorable pricing variance (driven by higher combustible pricing, notably inGermany , partly offset by lower heated tobacco unit pricing). -74-
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Operating income, excluding unfavorable currency, increased by 4.0%, mainly reflecting: a favorable pricing variance; and lower manufacturing costs (notably inItaly ); partly offset by higher marketing, administration and research costs (largely related to increased investments behind reduced-risk products, as well as 2020 asset impairment and exit costs).
Excluding asset impairment and exit costs of
Change Variance
Financial Summary - Fav./(Unfav.) Fav./(Unfav.)
Six Months Ended June 30, Excl. Cur- Vol/ Cost/
(in millions) 2020 2019 Total Curr. Total rency Price Mix Other
Net Revenues $ 5,010 $ 4,736 5.8 % 9.4 % $ 274 $ (170 ) $ 60 $ 384 $ -
Operating Income $ 2,336 $ 2,091 11.7 % 17.9 % $ 245 For the six months endedJune 30, 2020 , net revenues, excluding unfavorable currency, increased by 9.4%, reflecting: favorable volume/mix, mainly driven by higher heated tobacco unit volume across the Region (notably inGermany ,Italy andPoland ), partly offset by lower cigarette volume (notably inItaly ,Poland andSpain , partly offset byGermany ); and a favorable pricing variance (driven by higher combustible pricing across the Region, notably inGermany , partly offset by lower heated tobacco unit and IQOS device pricing). Operating income, excluding unfavorable currency, increased by 17.9%, mainly reflecting: favorable volume/mix, driven by the same factors as for net revenues noted above; a favorable pricing variance; and lower manufacturing costs (notably inGermany andItaly ); partly offset by higher marketing, administration and research costs (largely related to increased investments behind reduced-risk products, notably inPoland , as well as 2020 asset impairment and exit costs).
Excluding asset impairment and exit costs of
Total market, PMI shipment volume and market share performance are shown in the
table below:
European Union Key Data Second-Quarter Six Months Year-to-Date
Change Change
2020 2019 % / pp 2020 2019 % / pp
Total Market (billion units) 115.5 124.5 (7.3 )% 224.6 231.8 (3.1 )%
PMI Shipment Volume (million
units)
Cigarettes 40,317 46,367 (13.0 )% 80,963 85,855 (5.7 )%
Heated Tobacco Units 4,227 3,043 38.9 % 8,888 5,336 66.6 %
Total European Union 44,544 49,410 (9.8 )% 89,851 91,191 (1.5 )%
PMI Market Share
Marlboro 17.8 % 18.0 % (0.2 ) 17.7 % 18.1 % (0.4 )
L&M 6.5 % 6.9 % (0.4 ) 6.5 % 6.8 % (0.3 )
Chesterfield 5.6 % 5.8 % (0.2 ) 5.6 % 5.9 % (0.3 )
Philip Morris 2.6 % 2.7 % (0.1 ) 2.6 % 2.8 % (0.2 )
HEETS 3.9 % 2.4 % 1.5 3.9 % 2.3 % 1.6
Others 3.0 % 3.0 % - 3.1 % 3.0 % 0.1
Total European Union 39.4 % 38.8 % 0.6 39.4 % 38.9 % 0.5
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In the second quarter, the estimated total market in the EU decreased by 7.3% to 115.5 billion units, mainly driven by: •Czech Republic , down by 16.7%, mainly reflecting lower border sales due to
lockdown measures;
•
estimated trade inventory movements related to a significant excise tax
increase on
market increased by 0.3%;
•
measures, as well as the impact of price increases in the first quarter of
2020;
•
•
sales due to lockdown measures;
partly offset by •Germany , up by 5.9%, or by 4.2% excluding the net favorable impact of
estimated trade inventory movements, primarily reflecting the favorable
impact of reduced out-bound tourism and lower cross-border (non-domestic)
purchases due to lockdown measures, partly offset by the impact of price
increases in April and
In the second quarter, our total shipment volume decreased by 9.8% to 44.5 billion units, reflecting: • lower cigarette shipment volume, mainly due to the lower total market, lower
market share (notably in
heated tobacco units) and the net unfavorable impact of estimated distributor
inventory movements (partially due to distributor inventory decreases,
following increases in the first quarter related to COVID-19, notably in
Italy and Spain );
partly offset by • higher heated tobacco unit shipment volume, driven by higher market share
(notably in
Excluding the net unfavorable impact of estimated distributor inventory movements, our total in-market sales in the Region decreased by 6.0%.
For the six months year-to-date, the estimated total market in the EU decreased by 3.1% to 224.6 billion units, notably due to: •Czech Republic , down by 11.5%, primarily reflecting the same factor as in the
quarter;
•
•
quarter; and
•
partly offset by •Germany , up by 4.9%, or by 2.3% excluding the net favorable impact of
estimated trade inventory movements, primarily reflecting the same factors as
in the quarter.
For the six months year-to-date, our total shipment volume decreased by 1.5% to
89.9 billion units, reflecting:
• lower cigarette shipment volume, mainly due to the lower total market, as
well as lower cigarette market share (notably in
reflecting out-switching to heated tobacco units);
partly offset by • higher heated tobacco unit shipment volume across the Region (notably in
Germany ,Italy andPoland ), driven by higher market share. -76-
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Table of ContentsEastern Europe : Financial Summary - Change Variance Quarters Ended June 30, Fav./(Unfav.) Fav./(Unfav.) Excl. Cur- Vol/ Cost/ (in millions) 2020 2019 Total Curr. Total rency Price Mix Other Net Revenues$ 783 $ 822 (4.7 )% 5.6 %$ (39 ) $ (85
)
For the three months endedJune 30, 2020 , the effects of the COVID-19 pandemic impacted our net revenues. Net revenues, excluding unfavorable currency, increased by 5.6%, reflecting: a favorable pricing variance, driven by higher combustible pricing (predominantly inRussia ), partly offset by lower IQOS device pricing (mainly inRussia ); and favorable volume/mix, driven by higher heated tobacco unit volume across the Region (primarily inRussia andUkraine ), partly offset by lower cigarette volume (mainly inRussia andUkraine ) and unfavorable cigarette mix inRussia . Operating income, excluding unfavorable currency, increased by 8.2%, mainly reflecting: a favorable pricing variance; favorable volume/mix, reflecting the same drivers as for net revenues noted above; and lower manufacturing costs; partially offset by higher marketing, administration and research costs (largely related to increased investments behind reduced-risk products, notably inRussia ).
Excluding asset impairment and exit costs of
Financial Summary - Change Variance
Six Months Ended June 30, Fav./(Unfav.) Fav./(Unfav.)
Excl. Cur- Vol/ Cost/
(in millions) 2020 2019 Total Curr. Total rency Price Mix Other
Net Revenues $ 1,571 $ 1,401 12.1 % 17.8 % $ 170 $ (79 ) $ 41 $ 208 $ -
Operating Income $ 365 $ 385 (5.2 )% 21.6 % $ (20 ) For the six months endedJune 30, 2020 , net revenues, excluding unfavorable currency, increased by 17.8%, reflecting: favorable volume/mix, predominantly driven by higher heated tobacco unit volume inRussia andUkraine , partly offset by unfavorable cigarette volume/mix inRussia and lower cigarette volume inUkraine ; and a favorable pricing variance, driven by higher combustible pricing (primarily inRussia ), partly offset by lower IQOS device pricing (mainly inRussia ). Operating income, excluding unfavorable currency, increased by 21.6%, mainly reflecting: favorable volume/mix, reflecting the same drivers as for net revenues noted above; and a favorable pricing variance; partly offset by higher manufacturing costs due toRussia ; and higher marketing, administration and research costs (primarily related to increased investments behind reduced-risk products, notably inRussia andUkraine ).
Excluding asset impairment and exit costs of
In the second quarter, the estimated total market inEastern Europe decreased, notably due to: •Russia , down by 4.1%, or by 6.6% excluding the net favorable impact of
estimated trade inventory movements, primarily reflecting the impact of price
increases, partly offset by the impact of a decrease in the prevalence of
illicit trade due to lockdown measures; and
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•
price increases and reduced adult smoker average daily consumption due to
lockdown measures.
For the six months year-to-date, the estimated total market in Eastern Europe
decreased, notably due to:
• Russia , down by 2.1%, or by 6.4% excluding the net favorable impact of
estimated trade inventory movements, primarily reflecting the same factors as
in the quarter; and
•
PMI Shipment Volume (million units) Second-Quarter
Six Months Year-to-Date
2020 2019 Change 2020 2019 Change
Cigarettes 23,657 27,080 (12.6 )% 45,076 47,400 (4.9 )%
Heated Tobacco Units 5,126 2,807 82.6 % 9,492 4,355 +100%
Total Eastern Europe 28,783 29,887 (3.7 )% 54,568 51,755 5.4 %
In the second quarter, our total shipment volume decreased by 3.7% to 28.8
billion units, mainly due to:
•
estimated distributor inventory movements, mainly reflecting the lower total
market, partly offset by a higher market share, driven by heated tobacco
units.
For the six months year-to-date, our total shipment volume increased by 5.4% to
54.6 billion units, mainly due to:
• Russia , up by 10.3%, primarily reflecting a higher market share, driven by
heated tobacco units, partly offset by the lower total market;
partly offset by •Ukraine , down by 5.7%, mainly due to the same factors as in the quarter.Middle East &Africa : Financial Summary - Change Variance Quarters Ended June 30, Fav./(Unfav.) Fav./(Unfav.) Excl. Cur- Vol/ Cost/ (in millions) 2020 2019 Total Curr. Total rency Price Mix Other Net Revenues$ 704 $ 1,004 (29.9 )% (28.3 )%$ (300 ) $ (16 ) $ 45 $ (335 ) $ 6 Operating Income$ 237 $ 441 (46.3 )% (47.4 )%$ (204 ) $
5
For the three months endedJune 30, 2020 , the effects of the COVID-19 pandemic impacted our net revenues. Net revenues, excluding unfavorable currency, decreased by 28.3%, primarily reflecting: unfavorable volume/mix, mainly due to lower cigarette volume (predominantly inNorth Africa , PMI Duty Free andSouth Africa , partly offset bySaudi Arabia ) and lower heated tobacco unit volume in PMI Duty Free; partially offset by a favorable pricing variance, driven mainly by combustible pricing inSaudi Arabia , partly offset byTurkey .
Operating income, excluding favorable currency, decreased by 47.4%, mainly reflecting: unfavorable volume/mix, due to the same factors as for net revenues noted above; partly offset by a favorable pricing variance.
Excluding asset impairment and exit costs of
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Financial Summary - Change Variance
Six Months Ended June 30, Fav./(Unfav.) Fav./(Unfav.)
Excl. Cur- Vol/ Cost/
(in millions) 2020 2019 Total Curr. Total rency Price Mix Other
Net Revenues $ 1,580 $ 1,931 (18.2 )% (17.2 )% $ (351 ) $ (18 ) $ 117 $ (411 ) $ (39 )
Operating Income $ 558 $ 785 (28.9 )% (27.1 )% $
(227 )
For the six months endedJune 30, 2020 , net revenues, excluding unfavorable currency, decreased by 17.2%, reflecting: unfavorable volume/mix, mainly due to lower cigarette volume (mainly in PMI Duty Free andTurkey , partly offset byKuwait ) and lower heated tobacco unit volume in PMI Duty Free; and lower fees for certain distribution rights billed to customers in certain markets, shown in "Cost/Other"; partially offset by a favorable pricing variance, driven by combustible pricing (mainly in the GCC, particularlySaudi Arabia ). Operating income, excluding unfavorable currency, decreased by 27.1%, mainly reflecting: unfavorable volume/mix, predominantly due to lower cigarette and heated tobacco unit volume in PMI Duty Free; and unfavorable "Cost/Other," mainly due to lower fees for certain distribution rights, as noted above for net revenues; partially offset by a favorable pricing variance.
Excluding asset impairment and exit costs of
In the second quarter, the estimated total market in theMiddle East &Africa decreased, mainly due to: •Egypt , down by 19.6%, notably reflecting pandemic-related supply-chain
shortages involving competitors' products and reductions in adult smoker
average daily consumption during lockdown;
•
travel restrictions and reduced passenger traffic due to the pandemic;
•
on all tobacco sales effective
•
estimated trade inventory movements, mainly reflecting the impact of lockdown
measures on adult smoker average daily consumption, as well as a higher
prevalence of illicit trade related to cut tobacco following significant
industry-wide price increases in 2019.
For the six months year-to-date, the estimated total market in theMiddle East &Africa decreased, mainly due to: •Egypt , down by 6.9%, notably reflecting the same factors as in the quarter;
•
quarter;
•
quarter; and
•
PMI Shipment Volume (million units) Second-Quarter
Six Months Year-to-Date
2020 2019 Change 2020 2019 Change
Cigarettes 27,188 31,659 (14.1 )% 57,184 64,963 (12.0 )%
Heated Tobacco Units 185 719 (74.3 )% 655 1,473 (55.5 )%
Total Middle East & Africa 27,373 32,378 (15.5 )% 57,839 66,436 (12.9 )%
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In the second quarter, our total shipment volume decreased by 15.5% to 27.4
billion units, notably due to:
•
estimated distributor inventory movements, mainly reflecting the lower total
market, partly offset by a higher market share, primarily driven by the
impact of supply chain shortages for competitors' products;
• PMI Duty Free, down by 94.4%, or by 82.1% excluding the net unfavorable
impact of estimated distributor inventory movements (driven by cigarettes),
mainly reflecting the lower total market due to the impact of government
travel restrictions and reduced passenger traffic due to the pandemic; and
•
partly offset by
•
distributor inventory movements of 1.7 billion cigarettes, largely
attributable to the timing of shipments in 2019, our in-market sales
increased by 11.2%, mainly driven by the reduced prevalence of non-domestic
products and the shift from duty-free to domestic sales due to the impact of
pandemic-related government travel restrictions and reduced passenger
traffic.
For the six months year-to-date, our total shipment volume decreased by 12.9% to
57.8 billion units, notably due to:
• PMI Duty Free, down by 55.9%, mainly reflecting the lower total market; and
•
market share, due primarily to adult smoker down-trading following the 2019
price increases.
South & Southeast Asia :
Financial Summary - Change Variance
Quarters Ended June 30, Fav./(Unfav.) Fav./(Unfav.)
Excl. Cur- Vol/ Cost/
(in millions) 2020 2019 Total Curr. Total rency Price Mix Other
Net Revenues $ 889 $ 1,248 (28.8 )% (25.1 )% $ (359 ) $
(46 )
For the three months endedJune 30, 2020 , the effects of the COVID-19 pandemic impacted our net revenues. Net revenues, excluding unfavorable currency, decreased by 25.1%, reflecting: unfavorable volume/mix, mainly due to lower cigarette volume inIndonesia andthe Philippines , partly offset by favorable mix inIndonesia ; and an unfavorable pricing variance, principally inIndonesia , partly offset bythe Philippines . Operating income, excluding unfavorable currency, decreased by 38.0%, primarily reflecting: unfavorable volume/mix, due to the same factors as for net revenues noted above; and an unfavorable pricing variance; partly offset by lower marketing, administration and research costs; and lower manufacturing costs (mainly inIndonesia ).
Excluding asset impairment and exit costs of
Financial Summary - Change Variance
Six Months Ended June 30, Fav./(Unfav.) Fav./(Unfav.)
Excl. Cur- Vol/ Cost/
(in millions) 2020 2019 Total Curr. Total rency Price Mix Other
Net Revenues $ 2,140 $ 2,361 (9.4 )% (8.2 )% $ (221 ) $ (27 ) $ 144 $ (338 ) $ -
Operating Income $ 888 $ 932 (4.7 )% (5.0 )% $ (44 ) $ 3 $ 144 $ (236 ) $ 45
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For the six months endedJune 30, 2020 , net revenues, excluding unfavorable currency, decreased by 8.2%, reflecting: unfavorable volume/mix, primarily due to lower cigarette volume inIndonesia ,Pakistan andthe Philippines , partly offset by favorable mix inIndonesia ; partially offset by a favorable pricing variance, principally driven bythe Philippines , partly offset byIndonesia . Operating income, excluding favorable currency, decreased by 5.0%, mainly reflecting: unfavorable volume/mix, due to the same factors as for net revenues noted above; partially offset by a favorable pricing variance; lower marketing, administration and research costs; and lower manufacturing costs (notably inIndonesia ).
Excluding lower asset impairment and exit costs of
South &
In the second quarter, the estimated total market in South &
estimated trade inventory movements, primarily reflecting the impact of
lockdown restrictions on tobacco product availability;
•
restrictions on the movement of certain products, including tobacco;
•
estimated trade inventory movements, mainly reflecting the impact of
pandemic-related measures on adult smoker average daily consumption, as well
as the impact of excise tax-driven price increases;
•
price increases in
2020, coupled with the impact of trade supply disruption on tobacco product
availability, due to lockdown measures; and
•
enforcement of nationwide quarantine, as well as industry-wide price
increases in the third quarter of 2019.
For the six months year-to-date, the estimated total market in South & Southeast
Asia decreased, notably due to:
• Bangladesh , down by 5.6%, primarily reflecting the same factor as in the
quarter;
•
•
estimated trade inventory movements, primarily reflecting the same factors as
in the quarter;
•
•
quarter.
PMI Shipment Volume (million units) Second-Quarter Six Months Year-to-Date
2020 2019 Change 2020 2019 Change
Cigarettes 33,346 46,376 (28.1 )% 70,941 87,868 (19.3 )%
Heated Tobacco Units - - - % - - - %
Total South &
In the second quarter, our total shipment volume decreased by 28.1% to 33.3
billion units, notably due to:
•
lower market share, mainly due to: the impact of elevated price gaps in the
tier one segment (partly due to the delay in minimum price enforcement),
adult smoker down-trading to the tax-advantaged 'below tier one' segment, and
the disproportionate impact of stricter public mobility restrictions in urban
areas, where PMI's share is higher;
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•
share; and
•
For the six months year-to-date, our total shipment volume decreased by 19.3% to 70.9 billion units, notably due to: •Indonesia , down by 18.2%, reflecting the lower total market, as well as a
lower market share, mainly due to the same factors as in the quarter;
•
•the Philippines , down by 17.7%, mainly reflecting the same factor as in the quarter.East Asia &Australia : Financial Summary - Change Variance Quarters Ended June 30, Fav./(Unfav.) Fav./(Unfav.) Excl. Cur- Vol/ Cost/ (in millions) 2020 2019 Total Curr. Total rency Price Mix Other Net Revenues$ 1,432 $ 1,521 (5.9 )% (5.1 )%$ (89 ) $ (12 ) $ 30 $ (107 ) $ - Operating Income$ 669 $ 642 4.2 % 5.9 %$ 27 $
(11 )
For the three months endedJune 30, 2020 , the effects of the COVID-19 pandemic impacted our net revenues. Net revenues, excluding unfavorable currency, decreased by 5.1%, reflecting: unfavorable volume/mix, mainly due to lower cigarette volume (primarily inAustralia andJapan ) and unfavorable heated tobacco unit mix inJapan , partly offset by higher heated tobacco unit volume inJapan ; partially offset by a favorable pricing variance, mainly driven by higher heated tobacco unit pricing inJapan and higher combustible pricing inAustralia , partly offset by lower IQOS device pricing inJapan . Operating income, excluding unfavorable currency, increased by 5.9%, mainly reflecting: lower manufacturing costs (notably related toJapan andKorea ); lower marketing, administration and research costs (primarily inJapan ); and a favorable pricing variance; partly offset by unfavorable volume/mix, due to the same factors as for net revenues noted above.
Excluding asset impairment and exit costs of
Financial Summary - Change Variance Six Months Ended June 30, Fav./(Unfav.)
Fav./(Unfav.)
Excl. Cur- Vol/ Cost/
(in millions) 2020 2019 Total Curr. Total rency Price Mix Other
Net Revenues $ 2,687 $ 2,842 (5.5 )% (4.7 )% $ (155 ) $ (21 ) $ 43 $ (177 ) $ -
Operating Income $ 1,155 $ 1,069 8.0 % 9.4 % $ 86 For the six months endedJune 30, 2020 , net revenues, excluding unfavorable currency, decreased by 4.7%, reflecting: unfavorable volume/mix, mainly due to lower cigarette volume inJapan , unfavorable volume/mix inAustralia , lower IQOS device volume inJapan and unfavorable heated tobacco unit mix inJapan , partly offset by higher heated tobacco unit volume inJapan ; partially offset by a favorable pricing variance, mainly driven by higher combustible pricing inAustralia and higher heated tobacco pricing inJapan , partly offset by lower IQOS device pricing inJapan . Operating income, excluding unfavorable currency, increased by 9.4%, mainly reflecting: lower marketing, administration and research costs (notably inJapan ); lower manufacturing costs (mainly related toJapan andKorea ); and a favorable pricing variance; partly offset by unfavorable volume/mix, primarily due to lower cigarette volume inJapan , unfavorable volume/mix inAustralia and unfavorable heated tobacco unit mix inJapan , partly offset by higher heated tobacco unit volume inJapan . -82-
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Excluding asset impairment and exit costs of
In the second quarter, the estimated total market in
social consumption occasions due to pandemic-related measures, as well as
adult smoker out-switching from cigarettes to the cigarillo category;
partly offset by
• Korea , up by 3.9%, notably driven by the shift of adult smokers from
duty-free to domestic purchases due to the pandemic-related decline in
international travel.
For the six months year-to-date, the estimated total market in
partly offset by •Korea , up by 3.8%, notably due the same factor as in the quarter. PMI Shipment Volume (million units) Second-Quarter
Six Months Year-to-Date
2020 2019 Change 2020 2019 Change
Cigarettes 12,071 13,845 (12.8 )% 24,370 25,958 (6.1 )%
Heated Tobacco Units 9,076 8,428 7.7 %
16,198 15,277 6.0 %
Total East Asia &
In the second quarter, our total shipment volume decreased by 5.1% to 21.1
billion units, notably in:
•
higher market share driven by heated tobacco units.
For the six months year-to-date, our total shipment volume decreased by 1.6% to 40.6 billion units, notably in: •Japan , down by 1.0%, or by 3.6% excluding the net favorable impact of
estimated distributor inventory movements, mainly due to the same factors as
in the quarter; and
•
the unfavorable impact of the growth of the cigarette new taste dimension
segment, in which PMI has a relatively low share, partly offset by the higher
total market.
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Table of ContentsLatin America &Canada : Financial Summary - Change Variance Quarters Ended June 30, Fav./(Unfav.) Fav./(Unfav.) Excl. Cur- Vol/ Cost/ (in millions) 2020 2019 Total Curr. Total rency Price Mix Other Net Revenues$ 368 $ 527 (30.2 )% (19.2 )%$ (159 ) $
(58 )
Note: Net Revenues include revenues from shipments of Platform 1 devices, heated tobacco units and accessories to Altria Group, Inc., commencing in the third quarter of 2019, for sale under license inthe United States . For the three months endedJune 30, 2020 , the effects of the COVID-19 pandemic impacted our net revenues. Net revenues, excluding unfavorable currency, decreased by 19.2%, mainly reflecting: unfavorable volume/mix, primarily due to lower cigarette volume inArgentina ,Colombia andMexico ; partly offset by a favorable pricing variance, predominantly driven by higher combustible pricing inMexico . Operating income, excluding unfavorable currency, decreased by 39.1%, primarily reflecting: unfavorable volume/mix (mainly due to lower cigarette volume inMexico ); partly offset by a favorable pricing variance; and lower marketing, administration and research costs (driven by the favorable net impact of 2019 and 2020 asset impairment and exit costs).
Excluding lower asset impairment and exit costs of
Financial Summary - Change Variance
Six Months Ended June 30, Fav./(Unfav.) Fav./(Unfav.)
Excl. Cur- Vol/ Cost/
(in millions) 2020 2019 Total Curr. Total rency Price Mix Other(1)
Net Revenues $ 816 $ 1,179 (30.8 )% (24.3 )% $
(363 )
(1) Cost/Other variance includes the impact of the RBH deconsolidation. Note: Net Revenues include revenues from shipments of Platform 1 devices, heated tobacco units and accessories to Altria Group, Inc., commencing in the third quarter of 2019, for sale under license inthe United States . For the six months endedJune 30, 2020 , net revenues, excluding unfavorable currency, decreased by 24.3%, reflecting: unfavorable volume/mix, due to lower cigarette volume, notably inArgentina andMexico ; and the unfavorable impact of the deconsolidation of RBH shown in "Cost/Other"; partly offset by a favorable pricing variance, mainly driven by higher combustible pricing inMexico . Operating income, excluding unfavorable currency, increased by +100%, notably reflecting a favorable comparison, shown in "Cost/Other," of charges recorded in the first half of 2020 of$4 million , related to asset impairment and exit costs associated with organizational design optimization, to charges recorded in the first half of 2019 of$456 million , related to the loss on deconsolidation of RBH ($239 million ), the Canadian tobacco litigation-related expense ($194 million ), and asset impairment and exit costs ($23 million ) associated with a plant closure inColombia . Excluding these 2020 and 2019 charges, and unfavorable currency of$41 million , operating income decreased by 39.0%, reflecting: unfavorable volume/mix, due to the same factor as for net revenues noted above; and the unfavorable impact of the deconsolidation of RBH, included in "Cost/Other"; partly offset by a favorable pricing variance.
In the second quarter, the estimated total market in
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•
of PMI brands) due to temporary factory shutdowns related to the pandemic, as
well as the impact of price increases, partly offset by the net favorable
impact of estimated trade inventory movements;
•
and adult smoker average daily consumption due to lockdown measures; and
•
estimated trade inventory movements (primarily related to
increases), mainly due to the impact of excise tax-driven price increases in
smoker average daily consumption;
partly offset by
•
trade due to: reduced price gaps with legal products and the impact of border
restrictions imposed as a result of the pandemic.
For the six months year-to-date, the estimated total market inLatin America &Canada decreased, notably due to: •Argentina , down by 6.3%, mainly reflecting the same factors as in the quarter;
•
and
•
estimated trade inventory movements, mainly due to the same factors as in the
quarter;
partly offset by
•
PMI Shipment Volume (million units) Second-Quarter
Six Months Year-to-Date
2020 2019 Change 2020 2019 Change
Cigarettes 14,780 18,472 (20.0 )% 29,843 36,052 (17.2 )%
Heated Tobacco Units 94 59 59.3 %
202 113 78.8 %
Total Latin America &
In the second quarter, our total shipment volume decreased by 19.7% to 14.9
billion units, notably due to:
•
lower market share, mainly due to the impact of retail out-of-stock of PMI
brands, as well as adult smoker down-trading to ultra-low-price brands
produced by local manufacturers; and
•
reflecting the net unfavorable impact of estimated trade inventory movements
noted above) and lower market share, primarily reflecting adult smoker
down-trading and the impact of the pandemic on adult smoker consumption
patterns.
For the six months year-to-date, our total shipment volume decreased by 16.9% to
30.0 billion units, or by 14.6% excluding the impact of the RBH deconsolidation,
notably due to:
• Argentina , down by 14.2%, primarily reflecting the same factors as in the
quarter;
•
of RBH; and
•
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Financial Review
Cash Flow Highlights
[[Image Removed: chart-1fcfbeac6c3e5e96bc2.jpg]][[Image Removed: chart-8fac64bde67f50568c4.jpg]][[Image Removed: chart-b52178b02864520d884.jpg]]
For the Six Months Ended June 30,
(in millions) 2020 2019
Net cash provided by operating activities $ 3,036 $ 4,683 Net cash used in investing activities
(134 ) (1,749 )
Net cash used in financing activities (5,503 ) (5,555 )
Net Cash Provided by Operating Activities
During the first six months of 2020, net cash provided by operating activities decreased by$1.6 billion compared with the first first six months of 2019. Excluding unfavorable currency movements of$248 million , net cash provided by operating activities decreased by$1.4 billion , due primarily to higher working capital requirements of$1.5 billion . The higher working capital requirements were primarily due to COVID-19 pandemic related build-up of inventory levels across our supply chain, as well as the timing of excise tax-paid inventory movements and excise tax payments, partially offset by less cash used for accounts receivable, due to the timing of sales and cash collections.
During the first six months of 2020, net cash used in investing activities decreased by$1.6 billion compared with the first six months of 2019. This decrease in net cash used in investing activities was primarily due to the reduction of cash in 2019 resulting from the deconsolidation of RBH and lower capital expenditures. For further details on the deconsolidation of RBH, see Note 19. Deconsolidation of RBH.
During the first six months of 2020, capital expenditures decreased by
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During the first six months of 2020, net cash used in financing activities decreased by$52 million compared with the first six months of 2019. The change was due primarily to higher proceeds from long-termU.S. dollar debt issuances ($2.3 billion in 2020 compared with$1.6 billion in 2019) and lower repayments on short-term borrowings, partially offset by higher long-term debt repayments ($3.6 billion in 2020 compared with$3.0 billion in 2019).
Debt and Liquidity
We define cash and cash equivalents as short-term, highly liquid investments, readily convertible to known amounts of cash that mature within a maximum of three months and have an insignificant risk of change in value due to interest rate or credit risk changes. As a policy, we do not hold any investments in structured or equity-linked products. Our cash and cash equivalents are predominantly held in demand deposits with institutions that have investment-grade long-term credit rating. As part of our cash management strategy and in order to manage counterparty exposure, we also enter into reverse repurchase agreements. Such agreements are collateralized with government or corporate securities held by a custodial bank and, at maturity, cash is paid back to PMI, and the collateral is returned to the bank. For the six months endedJune 30, 2020 and the full-year 2019, the activities for such reverse repurchase agreements were not material. We utilize long-term and short-term debt financing, including a commercial paper program that is regularly used to finance ongoing liquidity requirements, as part of our overall cash management strategy. Our ability to access the capital and credit markets as well as overall dynamics of these markets may impact borrowing costs. We expect that the combination of our long-term and short-term debt financing, the commercial paper program and the committed credit facilities, coupled with our operating cash flows, will enable us to meet our liquidity requirements. Credit Ratings - The cost and terms of our financing arrangements as well as our access to commercial paper markets may be affected by applicable credit ratings. AtJune 30, 2020 , our credit ratings and outlook by major credit rating agencies were as follows: Short-term Long-term Outlook Moody's P-1 A2 Stable Standard & Poor's A-1 A Stable Fitch F1 A Stable Credit Facilities - OnJanuary 31, 2020 , we entered into an agreement to amend and extend the term of our$2.0 billion 364-day revolving credit facility fromFebruary 4, 2020 , toFebruary 2, 2021 . OnFebruary 10, 2020 , we entered into a new$2.0 billion multi-year revolving credit facility, expiring onFebruary 10, 2025 . The new credit facility replaced the$2.5 billion multi-year revolving credit facility, which was terminated effectiveFebruary 10, 2020 . We had no borrowings outstanding under the terminated facility, which was due to expire onFebruary 28, 2021 .
At
(in billions)
Committed
Credit
Type Facilities
364-day revolving credit, expiring
3.5
Multi-year revolving credit, expiring February 10, 2025 2.0
Total facilities $ 7.5
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At
All banks participating in our committed credit facilities have an investment-grade long-term credit rating from the credit rating agencies. We continuously monitor the credit quality of our banking group, and at this time we are not aware of any potential non-performing credit provider. These facilities do not include any credit rating triggers, material adverse change clauses or any provisions that could require us to post collateral. The$3.5 billion multi-year revolving credit facility in the table above requires us to maintain a ratio of consolidated earnings before interest, taxes, depreciation and amortization ("consolidated EBITDA") to consolidated interest expense of not less than 3.5 to 1.0 on a rolling four-quarter basis. AtJune 30, 2020 , our ratio calculated in accordance with the agreements was 11.8 to 1.0. We expect to continue to meet our covenants. The terms "consolidated EBITDA" and "consolidated interest expense," both of which include certain adjustments, are defined in the facility agreement previously filed with theU.S. Securities and Exchange Commission . In addition to the committed credit facilities discussed above, certain of our subsidiaries maintain short-term credit arrangements to meet their respective working capital needs. These credit arrangements, which amounted to approximately$2.6 billion atJune 30, 2020 and$2.7 billion atDecember 31, 2019 , are for the sole use of our subsidiaries. Borrowings under these arrangements and other bank loans amounted to$236 million atJune 30, 2020 , and$338 million atDecember 31, 2019 . Commercial Paper Program - We continue to have access to liquidity in the commercial paper market through programs in place in theU.S. and inEurope having an aggregate issuance capacity of$8.0 billion . AtJune 30, 2020 , we had commercial paper outstanding of$45 million . AtDecember 31, 2019 , we had no commercial paper outstanding. The average commercial paper balance outstanding during the first six months of 2020 was$2.0 billion . The average commercial paper balance outstanding during 2019 was$2.3 billion . Sale of Accounts Receivable - To mitigate credit risk and enhance cash and liquidity management we sell trade receivables to unaffiliated financial institutions. These arrangements allow us to sell, on an ongoing basis, certain trade receivables without recourse. The trade receivables sold are generally short-term in nature and are removed from the condensed consolidated balance sheets. We sell trade receivables under two types of arrangements, servicing and nonservicing. Our operating cash flows were positively impacted by the amount of the trade receivables sold and derecognized from the condensed consolidated balance sheets, which remained outstanding with the unaffiliated financial institutions. The trade receivables sold that remained outstanding under these arrangements as ofJune 30, 2020 , andJune 30, 2019 were$0.6 billion and$0.6 billion , respectively. The net proceeds received are included in cash provided by operating activities in the condensed consolidated statements of cash flows.
For further details, see Note 15. Sale of Accounts Receivable to our condensed consolidated financial statements.
Debt - Our total debt was
OnFebruary 11, 2020 , we filed a shelf registration statement with theU.S. Securities and Exchange Commission , under which we may from time to time sell debt securities and/or warrants to purchase debt securities over a three-year period.
Our debt issuances in the first six months of 2020 were as follows: (in millions)
Type Face Value Interest Rate Issuance Maturity
U.S. dollar notes (a) $750 1.125% May 2020 May 2023
U.S. dollar notes (a) $750 1.500% May 2020 May 2025
U.S. dollar notes (a) $750 2.100% May 2020 May 2030
(a) Interest on these notes is payable semi-annually in arrears beginning in
Guarantees - AtJune 30, 2020 , we were contingently liable for guarantees of our own performance, of which$0.3 billion were related to our obligations under indemnity agreements to enable appeals of customs assessments against our distributors. -88-
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Additionally, we have other guarantees of our own performance, which are primarily related to excise taxes on the shipment of our products. There is no liability in the condensed consolidated financial statements associated with these guarantees. These guarantees have not had, and are not expected to have, a significant impact on PMI's liquidity.
Equity and Dividends
We discuss our stock awards as of
During 2019, we did not repurchase any shares under a share repurchase program, and we do not presently intend to repurchase shares of our common stock in 2020. Dividends paid in the first six months of 2020 were$3.7 billion . During the third quarter of 2019, our Board of Directors approved a 2.6% increase in the quarterly dividend to$1.17 per common share. As a result, the present annualized dividend rate is$4.68 per common share. Market Risk Counterparty Risk - We predominantly work with financial institutions with strong short- and long-term credit ratings as assigned byStandard & Poor's and Moody's. These banks are also part of a defined group of relationship banks. Non-investment grade institutions are only used in certain emerging markets to the extent required by local business needs. We have a conservative approach when it comes to choosing financial counterparties and financial instruments. As such, we do not invest or hold investments in any structured or equity-linked products. The majority of our cash and cash equivalents is currently invested in demand deposits maturing within less than 30 days. We continuously monitor and assess the credit worthiness of all our counterparties. Derivative Financial Instruments - We operate in markets outside ofthe United States of America , with manufacturing and sales facilities in various locations throughout the world. Consequently, we use certain financial instruments to manage our foreign currency and interest rate exposure. We use derivative financial instruments principally to reduce our exposure to market risks resulting from fluctuations in foreign exchange and interest rates by creating offsetting exposures. We are not a party to leveraged derivatives and, by policy, do not use derivative financial instruments for speculative purposes. See Note 5. Financial Instruments, Note 11. Fair Value Measurements, and Note 13. Balance Sheet Offsetting to our condensed consolidated financial statements for further details on our derivative financial instruments and the related collateral arrangements.
Contingencies
See Note 8. Contingencies to our condensed consolidated financial statements for a discussion of contingencies.
Cautionary Factors That May Affect Future Results
Forward-Looking and Cautionary Statements We may from time to time make written or oral forward-looking statements, including statements contained in filings with theSEC , in reports to stockholders and in press releases and investor webcasts. You can identify these forward-looking statements by use of words such as "strategy," "expects," "continues," "plans," "anticipates," "believes," "will," "estimates," "intends," "projects," "goals," "targets," "forecasts" and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. We cannot guarantee that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions. Our RRPs constitute a new product category in its early stages that is less predictable than our mature cigarette business. Achievement of future results is subject to risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from those anticipated, estimated or projected. Investors should bear this in mind as they consider forward-looking statements and whether to invest in or remain invested in our securities. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, we are identifying important factors that, individually or in the aggregate, could cause actual results and outcomes to differ materially from those contained in any forward-looking statements made by us; any such statement is -89-
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qualified by reference to the following cautionary statements. We elaborate on these and other risks we face throughout this document, particularly in the "Business Environment" section. You should understand that it is not possible to predict or identify all risk factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. We do not undertake to update any forward-looking statement that we may make from time to time, except in the normal course of our public disclosure obligations. Risks Related to Our Business and Industry Consumption of tax-paid cigarettes continues to decline in many of our markets. This decline is due to multiple factors, including increased taxes and pricing, governmental actions, the diminishing social acceptance of smoking, continuing economic and geopolitical uncertainty, and the continuing prevalence of illicit products. These factors and their potential consequences are discussed more fully below and in the "Business Environment" section. Cigarettes are subject to substantial taxes. Significant increases in cigarette-related taxes have been proposed or enacted and are likely to continue to be proposed or enacted in numerous jurisdictions. These tax increases may disproportionately affect our profitability and make us less competitive versus certain of our competitors. Tax regimes, including excise taxes, sales taxes and import duties, can disproportionately affect the retail price of cigarettes versus other combustible tobacco products, or disproportionately affect the relative retail price of our cigarette brands versus cigarette brands manufactured by certain of our competitors. Because our portfolio is weighted toward the premium-price cigarette category, tax regimes based on sales price can place us at a competitive disadvantage in certain markets. As a result, our volume and profitability may be adversely affected in these markets. Increases in cigarette taxes are expected to continue to have an adverse impact on our sales of cigarettes, due to resulting lower consumption levels, a shift in sales from manufactured cigarettes to other combustible tobacco products and from the premium-price to the mid-price or low-price cigarette categories, where we may be under-represented, from local sales to legal cross-border purchases of lower price products, or to illicit products such as contraband, counterfeit and "illicit whites." Our business faces significant governmental action aimed at increasing regulatory requirements with the goal of reducing or preventing the use of tobacco products. Governmental actions, combined with the diminishing social acceptance of smoking and private actions to restrict smoking, have resulted in reduced industry volume in many of our markets, and we expect that such factors will continue to reduce consumption levels and will increase down-trading and the risk of counterfeiting, contraband, "illicit whites" and legal cross-border purchases. Significant regulatory developments will continue to take place over the next few years in most of our markets, driven principally by theWorld Health Organization's Framework Convention on Tobacco Control ("FCTC"). Since it came into force in 2005, the FCTC has led to increased efforts by tobacco control advocates and public health organizations to promote increasingly restrictive regulatory measures on the marketing and sale of tobacco products to adult smokers. Regulatory initiatives that have been proposed, introduced or enacted include:
• restrictions on or licensing of outlets permitted to sell cigarettes;
• the levying of substantial and increasing tax and duty charges;
• restrictions or bans on advertising, marketing and sponsorship;
• the display of larger health warnings, graphic health warnings and other
labeling requirements;
• restrictions on packaging design, including the use of colors, and plain
packaging;
• restrictions on packaging and cigarette formats and dimensions;
• restrictions or bans on the display of tobacco product packaging at the
point of sale and restrictions or bans on cigarette vending machines;
• requirements regarding testing, disclosure and performance standards for
tar, nicotine, carbon monoxide and other smoke constituents;
• disclosure, restrictions, or bans of tobacco product ingredients;
• increased restrictions on smoking in public and work places and, in some
instances, in private places and outdoors;
• regulation, restrictions or prohibitions of novel tobacco or
nicotine-containing products;
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• elimination of duty free sales and duty free allowances for travelers;
• encouraging litigation against tobacco companies; and
• excluding tobacco companies from transparent public dialogue regarding
public health and other policy matters.
Our financial results could be significantly affected by regulatory initiatives resulting in a significant decrease in demand for our brands, in particular requirements that lead to a commoditization of tobacco products or impede adult consumers' ability to convert to our RRPs, as well as any significant increase in the cost of complying with new regulatory requirements. Litigation related to tobacco use and exposure to environmental tobacco smoke could substantially reduce our profitability and could severely impair our liquidity. There is litigation related to tobacco products pending in certain jurisdictions. Damages claimed in some tobacco-related litigation are significant and, in certain cases inBrazil ,Canada , andNigeria , range into the billions ofU.S. dollars. We anticipate that new cases will continue to be filed. The FCTC encourages litigation against tobacco product manufacturers. It is possible that our consolidated results of operations, cash flows or financial position could be materially affected in a particular fiscal quarter or fiscal year by an unfavorable outcome or settlement of certain pending litigation. See Note 8. Contingencies to our condensed consolidated financial statements for a discussion of pending litigation and "Business Environment-Reduced-Risk Products (RRPs)-Legal Challenges to RRPs." We face intense competition, and our failure to compete effectively could have a material adverse effect on our profitability and results of operations. We compete primarily on the basis of product quality, brand recognition, brand loyalty, taste, R&D, innovation, packaging, customer service, marketing, advertising and retail price and, increasingly, adult smoker willingness to convert to our RRPs. We are subject to highly competitive conditions in all aspects of our business. The competitive environment and our competitive position can be significantly influenced by weak economic conditions, erosion of consumer confidence, competitors' introduction of lower-price products or innovative products, higher tobacco product taxes, higher absolute prices and larger gaps between retail price categories, and product regulation that diminishes the ability to differentiate tobacco products and restricts adult consumer access to truthful and non-misleading information about our RRPs. Competitors include three large international tobacco companies, new market entrants, particularly with respect to innovative products, several regional and local tobacco companies and, in some instances, state-owned tobacco enterprises, principally inAlgeria ,Egypt , the PRC,Taiwan ,Thailand andVietnam . Industry consolidation and privatizations of state-owned enterprises have led to an overall increase in competitive pressures. Some competitors have different profit and volume objectives, and some international competitors are susceptible to changes in different currency exchange rates. Certain new market entrants may alienate consumers from innovative products through inappropriate marketing campaigns and messaging and inferior product satisfaction, while not relying on scientific substantiation based on appropriate R&D protocols and standards. The growing use of digital media could increase the speed and extent of the dissemination of inaccurate and misleading information about our RRPs. Because we have operations in numerous countries, our results may be influenced by economic, regulatory and political developments, natural disasters, pandemics or conflicts. Some of the countries in which we operate face the threat of civil unrest and can be subject to regime changes. In others, nationalization, terrorism, conflict and the threat of war may have a significant impact on the business environment. Natural disasters, pandemics, economic, political, regulatory or other developments could disrupt our supply chain, manufacturing capabilities or distribution capabilities. In addition, such developments could increase costs of our materials and operations and lead to loss of property or equipment that are critical to our business in certain markets and difficulty in staffing and managing our operations, all of which could reduce our volumes, revenues and net earnings. We discuss risks associated with the COVID-19 pandemic below. In certain markets, we are dependent on governmental approvals of various actions such as price changes, and failure to obtain such approvals could impair growth of our profitability. In addition, despite our high ethical standards and rigorous control and compliance procedures aimed at preventing and detecting unlawful conduct, given the breadth and scope of our international operations, we may not be able to detect all potential improper or unlawful conduct by our employees and partners. -91-
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Our business, results of operations, cash flows and financial position will be adversely impacted during the continuation of the COVID-19 pandemic. The COVID-19 pandemic has created significant societal and economic disruption, and resulted in closures of stores, factories and offices, and restrictions on manufacturing, distribution and travel, all of which will adversely impact our business, results of operations, cash flows and financial position during the continuation of the pandemic. Our business continuity plans and other safeguards may not be effective to mitigate the results of the pandemic. Currently, significant risks include our diminished ability to convert adult smokers to our RRPs, significant volume declines in our duty-free business and certain other key markets, disruptions or delays in our manufacturing and supply chain, increased currency volatility, and delays in certain cost saving, transformation and restructuring initiatives. Our business could also be adversely impacted if key personnel or a significant number of employees or business partners become unavailable due to the COVID-19 outbreak. The significant adverse impact of COVID-19 on the economic or political conditions in markets in which we operate could result in changes to the preferences of our adult consumers and lower demand for our products, particularly for our mid-price or premium-price brands. Continuation of the pandemic could disrupt our access to the credit markets or increase our borrowing costs. Governments may temporarily be unable to focus on the development of science-based regulatory frameworks for the development and commercialization of RRPs or on the enforcement or implementation of regulations that are significant to our business. In addition, messaging about the potential negative impacts of the use of our products on COVID-19 risks may lead to increasingly restrictive regulatory measures on the sale and use of our products, negatively impact demand for our products, the willingness of adult consumers to switch to our RRPs and our efforts to advocate for the development of science-based regulatory frameworks for the development and commercialization of RRPs. The impact of these risks also depends on factors beyond our knowledge or control, including the duration and severity of the outbreak, its recurrence in our key markets, actions taken to contain its spread and to mitigate its public health effects, and the ultimate economic consequences thereof. We may be unable to anticipate changes in adult consumer preferences. Our business is subject to changes in adult consumer preferences, which may be influenced by local economic conditions. To be successful, we must: • promote brand equity successfully;
• anticipate and respond to new adult consumer trends;
• develop new products and markets and broaden brand portfolios;
• improve productivity;
• convince adult smokers to convert to our RRPs;
• ensure adequate production capacity to meet demand for our products; and
• be able to protect or enhance margins through price increases.
In periods of economic uncertainty, adult consumers may tend to purchase lower-price brands, and the volume of our premium-price and mid-price brands and our profitability could suffer accordingly. Such down-trading trends may be reinforced by regulation that limits branding, communication and product differentiation. The financial and business performance of our reduced-risk products is less predictable than our cigarette business. Our RRPs are novel products in a new category, and the pace at which adult smokers adopt them may vary, depending on the competitive, regulatory, fiscal and cultural environment, and other factors in a specific market. There may be periods of accelerated growth and periods of slower growth for these products, the timing and drivers of which may be more difficult for us to predict versus our mature cigarette business. The impact of this lower predictability on our projected results for a specific period may be significant, particularly during the early stages of this new product category and during the COVID-19 pandemic. We lose revenues as a result of counterfeiting, contraband, cross-border purchases, "illicit whites," non-tax-paid volume produced by local manufacturers, and counterfeiting of our Platform 1 device and heated tobacco units. Large quantities of counterfeit cigarettes are sold in the international market. We believe thatMarlboro is the most heavily counterfeited international cigarette brand, although we cannot quantify the revenues we lose as a result of this activity. In addition, our revenues are reduced by contraband, legal cross-border purchases, "illicit whites" and non-tax-paid volume produced by local -92-
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manufacturers. Our revenues and consumer satisfaction with our Platform 1 device and heated tobacco units may be adversely affected by counterfeit products that do not meet our product quality standards and scientific validation procedures. From time to time, we are subject to governmental investigations on a range of matters. Investigations include allegations of contraband shipments of cigarettes, allegations of unlawful pricing activities within certain markets, allegations of underpayment of income taxes, customs duties and/or excise taxes, allegations of false and misleading usage of descriptors, allegations of unlawful advertising, and allegations of unlawful labor practices. We cannot predict the outcome of those investigations or whether additional investigations may be commenced, and it is possible that our business could be materially affected by an unfavorable outcome of pending or future investigations. See Note 8. Contingencies-Other Litigation and "Management's Discussion and Analysis of Financial Condition and Results of Operations-Operating Results by Business Segment-Business Environment-Governmental Investigations" for a description of certain governmental investigations to which we are subject. We may be unsuccessful in our attempts to introduce reduced-risk products, and regulators may not permit the commercialization of these products or the communication of scientifically substantiated risk-reduction claims. Our key strategic priorities are: to develop and commercialize products that present less risk of harm to adult smokerswho switch to those products versus continued smoking; and to convince current adult smokerswho would otherwise continue to smoke to switch to those RRPs. For our efforts to be successful, we must: develop RRPs that such adult smokers find acceptable alternatives to smoking; conduct rigorous scientific studies to substantiate that they reduce exposure to harmful and potentially harmful constituents in smoke and, ultimately, that these products present, are likely to present, or have the potential to present less risk of harm to adult smokerswho switch to them versus continued smoking; and effectively advocate for the development of science-based regulatory frameworks for the development and commercialization of RRPs, including communication of scientifically substantiated information to enable adult smokers to make better consumer choices. We might not succeed in our efforts. If we do not succeed, but others do, or if heat-not-burn products are inequitably regulated compared to other RRP categories without regard to the totality of the scientific evidence available for such products, we may be at a competitive disadvantage. In addition, actions of some market entrants, such as the inappropriate marketing of e-vapor products to youth, as well as alleged health consequences associated with the use of certain e-vapor products, may unfavorably impact public opinion and/or mischaracterize all e-vapor products or other RRPs to consumers, regulators and policy makers without regard to the totality of scientific evidence for specific products. This may impede our efforts to advocate for the development of science-based regulatory frameworks for the development and commercialization of RRPs. We cannot predict whether regulators will permit the sale and/or marketing of RRPs with scientifically substantiated risk-reduction claims. Such restrictions could limit the success of our RRPs. Moreover, theFDA's premarket tobacco product and modified risk tobacco product authorizations of a version of our Platform 1 product are subject to strict marketing, reporting and other requirements and is not a guarantee that the product will remain authorized, particularly if there is a significant uptake in youth or non-smoker initiation. We may be unsuccessful in our efforts to differentiate reduced-risk products and cigarettes with respect to taxation. To date, we have been largely successful in demonstrating to regulators that our RRPs are not cigarettes, and as such they are generally taxed either as a separate category or as other tobacco products, which typically yields more favorable tax rates than cigarettes. If we cease to be successful in these efforts, RRP unit margins may be adversely affected. Our reported results could be adversely affected by unfavorable currency exchange rates, and currency devaluations could impair our competitiveness. We conduct our business primarily in local currency and, for purposes of financial reporting, the local currency results are translated intoU.S. dollars based on average exchange rates prevailing during a reporting period. During times of a strengtheningU.S. dollar, our reported net revenues, operating income and EPS will be reduced because the local currency translates into fewerU.S. dollars. During periods of economic crises, such as during the ongoing COVID-19 pandemic, foreign currencies may be devalued significantly against theU.S. dollar, reducing our margins. Actions to recover margins may result in lower volume and a weaker competitive position. Changes in the earnings mix and changes in tax laws may result in significant variability in our effective tax rates. Our ability to receive payments from foreign subsidiaries or to repatriate royalties and dividends could be restricted by local country currency exchange controls and other regulations. The Tax Cuts and Jobs Act that was signed into law inDecember 2017 constitutes a major change to theU.S. tax system. Our estimated impact of the Tax Cuts and Jobs Act is based on management's current interpretations, and our analysis is ongoing. Our -93-
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final tax liability may be materially different from current estimates due to developments such as implementing regulations and clarifications. In future periods, our effective tax rate and our ability to recover deferred tax assets could be subject to additional uncertainty as a result of such developments. Furthermore, changes in the earnings mix or applicable foreign tax laws may result in significant variability in our effective tax rates. Because we are aU.S. holding company, our most significant source of funds is distributions from our non-U.S. subsidiaries. Certain countries in which we operate have adopted or could institute currency exchange controls and other regulations that limit or prohibit our local subsidiaries' ability to convert local currency intoU.S. dollars or to make payments outside the country. This could subject us to the risks of local currency devaluation and business disruption. Our ability to grow profitability may be limited by our inability to introduce new products, enter new markets or improve our margins through higher pricing and improvements in our brand and geographic mix. Our profit growth may suffer if we are unable to introduce new products or enter new markets successfully, to raise prices or to improve the proportion of our sales of higher margin products and in higher margin geographies. We may be unable to expand our brand portfolio through successful acquisitions or the development of strategic business relationships. One element of our growth strategy is to strengthen our brand portfolio and market positions through selective acquisitions and the development of strategic business relationships. Acquisition and strategic business development opportunities are limited and present risks of failing to achieve efficient and effective integration, strategic objectives and anticipated revenue improvements and cost savings. There is no assurance that we will be able to acquire attractive businesses on favorable terms, or that future acquisitions or strategic business developments will be accretive to earnings. Government mandated prices, production control programs, shifts in crops driven by economic conditions and the impact of climate change may increase the cost or reduce the quality of the tobacco and other agricultural products used to manufacture our products. As with other agricultural commodities, the price of tobacco leaf and cloves can be influenced by imbalances in supply and demand and the impacts of natural disasters and pandemics such as COVID-19, and crop quality can be influenced by variations in weather patterns, including those caused by climate change. Tobacco production in certain countries is subject to a variety of controls, including government mandated prices and production control programs. Changes in the patterns of demand for agricultural products could cause farmers to produce less tobacco or cloves. Any significant change in tobacco leaf and clove prices, quality and quantity could affect our profitability and our business. Our ability to achieve our strategic goals may be impaired if we fail to attract and retain the best global talent. To be successful, we must continue transforming our culture and ways of working, align our talent with our business needs, innovate and transform to a consumer-centric business. We compete for talent, including in areas that are new to us, such as digital and technical solutions, with companies in the consumer products, technology and other sectors that enjoy greater societal acceptance. As a result, we may be unable to attract and retain the best global talent with the right degree of diversity, experience and skills to achieve our strategic goals. The failure of our information systems to function as intended or their penetration by outside parties with the intent to corrupt them or our failure to comply with privacy laws and regulations could result in business disruption, litigation and regulatory action, and loss of revenue, assets or personal or other confidential data. We use information systems to help manage business processes, collect and interpret data and communicate internally and externally with employees, suppliers, consumers, customers and others. Some of these information systems are managed by third-party service providers. We have backup systems and business continuity plans in place, and we take care to protect our systems and data from unauthorized access. Nevertheless, failure of our systems to function as intended, or penetration of our systems by outside parties intent on extracting or corrupting information or otherwise disrupting business processes, could place us at a competitive disadvantage, result in a loss of revenue, assets or personal or other sensitive data, litigation and regulatory action, cause damage to our reputation and that of our brands and result in significant remediation and other costs. Failure to protect personal data, respect the rights of data subjects, and adhere to strict cybersecurity protocols could subject us to substantial fines and other legal challenges under regulations such as the EU General Data Protection Regulation. As we are increasingly relying on digital platforms in our business, the magnitude of these risks is likely to increase. -94-
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We may be unable to adequately protect our intellectual property rights, and
disputes relating to intellectual property rights could harm our business.
Our intellectual property rights are valuable assets, and their protection is
important to our business. If the steps we take to protect our intellectual
property rights globally, including through a combination of trademark, design,
patent and other intellectual property rights, are inadequate, or if others
infringe or misappropriate our intellectual property rights, notwithstanding
legal protection, our business could suffer. Intellectual property rights of
third parties may limit our ability to introduce new products or improve the
quality of existing products in one or more markets. Competitors or other third
parties may claim that we infringe their intellectual property rights. Any such
claims, regardless of merit, could divert management's attention, be costly,
disruptive, time-consuming and unpredictable and expose us to litigation costs
and damages, and impede our ability to manufacture and sell new products or
improve existing products. If, as a result, we are unable to manufacture or sell
our RRPs or improve their quality in one or more markets, our ability to convert
adult smokers to our RRPs in such markets would be adversely affected. See Note
8. Contingencies- Other Litigation to our condensed consolidated financial
statements for a description of certain intellectual property proceedings.
We may be required to replace third-party contract manufacturers or service
providers with our own resources.
In certain instances, we contract with third parties to manufacture some of our
products or product parts or to provide other services. We may be unable to
renew these agreements on satisfactory terms for numerous reasons, including
government regulations. Accordingly, our costs may increase significantly if we
must replace such third parties with our own resources.
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