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, associated electronic devices and accessories, and other nicotine-containing products in markets outsidethe United States . In addition, we ship versions of our Platform 1 device and consumables to Altria Group, Inc. for sale under license inthe United States , where these products have received marketing authorizations from theU.S. Food and Drug Administration ("FDA") under the premarket tobacco product application ("PMTA") pathway; the FDA has also authorized the marketing of a version of our Platform 1 device and its consumables as a Modified Risk Tobacco Product ("MRTP"), finding that an exposure modification order for these products is appropriate to promote the public health. 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. We describe the PMTA and MRTP orders in more detail in the "Business Environment" section of this Item 2. 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 smoke-free product portfolio includes heat-not-burn and nicotine-containing vapor products.
We manage our business in six operating segments:
•European Union ("EU");
•Eastern Europe ("EE");
•Middle East & Africa ("ME&A"), which includes our international duty free
business;
•South & Southeast Asia ("S&SA");
•East Asia & Australia ("EA&A"); and
•Latin America & Canada ("LA&C"), which includes transactions under license with
Altria Group, Inc. for the distribution of our Platform 1 product in the United
States .
Our cigarettes are sold in more than 175 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 smokers who 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 devices produced by third-party electronics manufacturing service
providers. Estimated costs associated with device 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
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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 subsidiaries currently are not limited by long-term debt or other agreements in their ability to pay cash dividends or to make other distributions 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 Three Months Ended
•Net Revenues - Net revenues of$7.6 billion for the three months endedMarch 31, 2021 increased by$0.4 billion , or 6.0%, from the comparable 2020 amount. The change in our net revenues from the comparable 2020 amount was driven by the following (variances not to scale with quarterly results): [[Image Removed: pm-20210331_g1.jpg]] During the quarter, net revenues, excluding favorable currency, increased by 2.9%, mainly reflecting: a favorable pricing variance (notably driven byGermany ,Japan ,the Philippines andTurkey , partly offset byIndonesia ); and higher fees for certain distribution rights billed to customers in certain markets, shown in "Other;" partly offset by unfavorable volume/mix, primarily due to lower cigarette volume (mainly inIndonesia ,Japan ,North Africa ,the Philippines , PMI Duty Free andSpain ), partially offset by higher heated tobacco unit volume (notably in the EU,Japan andRussia , partly offset by PMI Duty Free).
Net revenues by product category for the three months ended
[[Image Removed: pm-20210331_g2.jpg]] [[Image Removed: pm-20210331_g3.jpg]]
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•Diluted Earnings Per Share - The changes in our reported diluted EPS ("diluted
EPS") for the three months ended
Diluted EPS % Growth
For the three months ended March 31, 2020 $ 1.17
2020 Asset impairment and exit costs
-
2020 Fair value adjustment for equity security investments 0.04
2020 Tax items -
Subtotal of 2020 items 0.04
2021 Asset impairment and exit costs (0.02)
2021 Tax items -
Subtotal of 2021 items (0.02)
Currency 0.10
Interest (0.02)
Change in tax rate 0.04
Operations 0.24
For the three months ended March 31, 2021 $ 1.55 32.5 %
Fair Value adjustment for equity security investments - In the first quarter of
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 the three months ended March 31, 2020 .
Asset impairment and exit costs - In the first quarter of 2021, we recorded
pre-tax asset impairment and exit costs of $48 million , representing $38 million
net of income tax and a diluted EPS charge of $0.02 per share, related to
product distribution restructuring in South Korea and the organizational design
optimization plan, primarily in Switzerland . The total pre-tax charge was
included in marketing, administration and research costs on the condensed
consolidated statements of earnings. For further details, see Note 16. Asset
Impairment and Exit Costs.
Currency - The favorable impact of $0.10 per share in the first quarter includes
$0.07 per share of transactional impact incurred in March 2020 , primarily from
the revaluation of Euro or Dollar denominated payables in certain markets, such
as Russia , where the local currency had seen a significant devaluation. The
favorable currency impact also includes the fluctuations of the U.S. dollar to
other currencies, especially against the Euro. This favorable currency movement
has impacted our profitability across our primary revenue markets and local
currency cost bases.
Interest - The unfavorable impact of interest was due primarily to lower interest income related to derivative financial instruments.
Income Taxes - The change in the tax rate that increased our diluted EPS by$0.04 per share in the table above was primarily due to corporate income tax rate reductions inIndonesia andthe Philippines , as well as changes in earnings mix by taxing jurisdiction. For further details, see Note 9. Income Taxes.
Operations - The increase in diluted EPS of
•East Asia &Australia : Favorable pricing, favorable volume/mix, and lower manufacturing costs; •European Union: Favorable volume/mix, lower manufacturing costs and favorable pricing, partially offset by higher marketing, administration and research costs; •Eastern Europe: Favorable volume/mix, lower manufacturing costs, favorable pricing and lower marketing, administration 42
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and research costs; •Middle East &Africa : Favorable pricing, lower marketing, administration and research costs, higher fees for certain distribution rights, and lower manufacturing costs, partially offset by unfavorable volume/mix; and •Latin America &Canada : Lower marketing, administration and research costs, partially offset by unfavorable volume/mix; partially offset by •South &Southeast Asia : Unfavorable volume/mix and unfavorable pricing, partially offset by lower marketing, administration and research costs.
For further details, see the "Consolidated Operating Results" and "Operating Results by Business Segment" sections of the following "Discussion and Analysis."
COVID-19 Impact on Our Business
COVID-19: Business Continuity Update
Since the onset of the COVID-19 pandemic, 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;
•All of PMI's cigarette and heated tobacco unit manufacturing facilities
globally are operational;
•COVID-related restrictions do not have a significant impact on the availability
of PMI's products to its customers and adult consumers; and
•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.
Nonetheless, significant uncertainty remains as the spread of the disease is
increasing in a number of markets, resulting in additional restrictions and
increasing risk of disruptions.
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Discussion and Analysis
Consolidated Operating Results
See pages 74-81 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:
(in millions) For the Three Months Ended March 31,
2021 2020 Change
Net revenues:
European Union $ 2,909 $ 2,535 14.8 %
Eastern Europe 796 788 1.0 %
Middle East & Africa 801 876 (8.6) %
South & Southeast Asia 1,173 1,251 (6.2) %
East Asia & Australia 1,472 1,255 17.3 %
Latin America & Canada 434 448 (3.1) %
Net revenues $ 7,585 $ 7,153 6.0 %
Operating income:
European Union $ 1,490 $ 1,158 28.7 %
Eastern Europe 261 99 +100%
Middle East & Africa 335 321 4.4 %
South & Southeast Asia 529 599 (11.7) %
East Asia & Australia 695 486 43.0 %
Latin America & Canada 134 126 6.3 %
Operating income $ 3,444 $ 2,789 23.5 %
Items affecting the comparability of results from operations were as follows:
•Asset impairment and exit costs - See Note 16. Asset Impairment and Exit Costs for details of the$48 million pre-tax charge and a breakdown of these costs by segment for the three months endedMarch 31, 2021 . 44
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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 Three Months Ended
2021 2020 Change
Combustible Products
European Union $ 1,950 $ 1,911 2.1 %
Eastern Europe 492 523 (6.0) %
Middle East & Africa 780 832 (6.3) %
South & Southeast Asia 1,171 1,251 (6.4) %
East Asia & Australia 648 642 1.0 %
Latin America & Canada 422 440 (4.1) %
Total Combustible Products $ 5,463 $ 5,598 (2.4) %
Reduced-Risk Products
European Union $ 959 $ 624 53.5 %
Eastern Europe 304 265 14.7 %
Middle East & Africa 21 44 (51.5) %
South & Southeast Asia 2 - - %
East Asia & Australia 824 613 34.4 %
Latin America & Canada 12 8 49.3 %
Total Reduced-Risk Products $ 2,122 $ 1,555 36.5 %
Total PMI Net Revenues $ 7,585 $ 7,153 6.0 %
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, heat-not-burn devices and related accessories, and other nicotine-containing products, which primarily include our e-vapor products.
PMI's heat-not-burn products include licensed KT&G heat-not-burn products.
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 , are included in Net Revenues of theLatin America &Canada segment. 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); 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 . 45
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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 Three Months Ended March
31,
2021 2020 Change
Cigarettes
European Union 36,769 40,646 (9.5) %
Eastern Europe 19,966 21,419 (6.8) %
Middle East & Africa 27,642 29,996 (7.8) %
South & Southeast Asia 34,888 37,595 (7.2) %
East Asia & Australia 11,362 12,299 (7.6) %
Latin America & Canada 14,885 15,063 (1.2) %
Total Cigarettes 145,512 157,018 (7.3) %
Heated Tobacco Units
European Union 6,426 4,661 37.9 %
Eastern Europe 5,635 4,366 29.1 %
Middle East & Africa 396 470 (15.7) %
South & Southeast Asia 33 - - %
East Asia & Australia 9,139 7,122 28.3 %
Latin America & Canada 105 108 (2.8) %
Total Heated Tobacco Units 21,734 16,727 29.9 %
Cigarettes and Heated Tobacco Units
European Union 43,195 45,307 (4.7) %
Eastern Europe 25,601 25,785 (0.7) %
Middle East & Africa 28,038 30,466 (8.0) %
South & Southeast Asia 34,921 37,595 (7.1) %
East Asia & Australia 20,501 19,421 5.6 %
Latin America & Canada 14,990 15,171 (1.2) %
Total Cigarettes and Heated Tobacco Units 167,246 173,745 (3.7) %
Heated tobacco units ("HTU") is the term we use to refer to heated tobacco
consumables, which include our HEETS, HEETS Creations, HEETS Dimensions, HEETS
Marlboro and HEETS FROM MARLBORO (defined collectively as HEETS), Marlboro
Dimensions, Marlboro HeatSticks and Parliament HeatSticks, as well as the
KT&G-licensed brands, Fiit and Miix (outside of
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, excludethe People's Republic of China and/or our duty free business. 2020 and 2021 estimates for total industry volume and market share in certain geographies reflect limitations on the availability and accuracy of industry data during pandemic-related restrictions. 46
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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
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 Three Months Ended March 31,
PMI Shipments (billion units) PMI Market Share (%)(1)
Total Market
Market (billion units) Total Cigarette Heated Tobacco Unit Total Heated Tobacco Unit
2021 2020 2021 2020 2021 2020 2021 2020 2021 2020 2021 2020
Total 611.2 615.6 167.2 173.7 145.5 157.0 21.7 16.7 26.8 27.5 3.5 2.8
European Union
France 8.2 8.3 3.8 4.0 3.7 4.0 0.1 - 43.6 44.5 0.6 0.4
Germany 17.4 16.0 7.1 6.7 6.5 6.4 0.6 0.4 40.9 42.2 3.6 2.4
Italy 15.9 15.7 9.6 9.2 7.5 7.8 2.2 1.4 52.8 51.9 11.3 7.4
Poland 10.8 10.8 4.0 4.3 3.4 3.9 0.6 0.5 36.7 40.0 5.4 4.3
Spain 9.6 10.4 2.7 3.7 2.6 3.5 0.1 0.1 31.2 30.9 1.2 0.9
Eastern Europe
Russia 48.6 46.9 15.7 15.0 12.1 12.4 3.6 2.6 31.3 32.3 7.7 6.5
Middle East & Africa
Saudi Arabia 5.5 4.3 2.2 1.1 2.2 1.0 - - 42.1 40.6 0.8 -
Turkey 25.2 25.9 11.0 10.2 11.0 10.2 - - 43.4 38.9 - -
South & Southeast Asia
Indonesia 70.8 67.4 19.9 20.4 19.9 20.4 - - 28.1 30.3 - -
Philippines 13.1 15.3 8.2 10.7 8.1 10.7 - - 62.4 70.1 0.2 -
East Asia & Australia
Australia 2.4 2.5 0.8 0.7 0.8 0.7 - - 32.7 28.0 - -
Japan 32.6 35.5 13.8 12.8 5.9 6.8 7.9 6.0 39.2 36.3 23.4 19.1
South Korea 16.8 16.2 3.4 3.5 2.2 2.4 1.1 1.1 20.1 21.8 6.8 6.6
Latin America & Canada
Argentina 9.1 8.0 5.3 5.3 5.3 5.3 - - 57.6 65.9 - -
Mexico 6.8 6.7 4.0 4.1 4.0 4.1 - - 59.6 61.0 0.3 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. "-" indicates volume below 50 million units and market share below 0.1%
Consolidated Operating Results for the Three Months Ended
Our total shipment volume decreased by 3.7%, due to:
•the EU, reflecting lower cigarette shipment volume, notably in theCzech Republic ,Poland andSpain , partly offset by higher heated tobacco unit shipment volume across the Region, notably inItaly ; •Eastern Europe, reflecting lower cigarette shipment volume, notably inUkraine , partly offset by higher heated tobacco unit shipment volume across the Region, primarily inRussia ; •Middle East &Africa , mainly reflecting lower cigarette shipment volume, mainly inNorth Africa (primarilyEgypt ) and PMI Duty Free, partly offset byTurkey ; 48
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•South &Southeast Asia , primarily reflecting lower cigarette shipment volume, primarily inIndonesia andthe Philippines , partly offset byPakistan ; and •Latin America &Canada , reflecting lower cigarette shipment volume, notably inColombia , partly offset byBrazil ; partly offset by •East Asia &Australia , reflecting higher heated tobacco unit shipment volume, primarily inJapan , partly offset by lower cigarette shipment volume, mainly inJapan .
First-Quarter Impact of Inventory Movements
Excluding the net unfavorable impact of estimated distributor inventory movements of approximately 0.9 billion units, our total in-market sales declined by 3.3%, due to a 6.2% decline in cigarettes, partly offset by a 22.7% increase in heated tobacco units. The net unfavorable impact of approximately 0.9 billion units reflected: •A net unfavorable impact of 2.0 billion cigarettes, mainly due to inventory movements in the first quarter of 2020 related to higher shipments to distributors at the onset of the pandemic; partly offset by •A net favorable impact of 1.1 billion heated tobacco units, mainly driven by inventory movements in the first quarter of 2020 due to the temporary shutdown of the company's Bologna manufacturing facility due to pandemic-related lockdown restrictions. PMI's total heated tobacco unit in-market sales volume in the quarter was 21.3 billion units, broadly consistent with heated tobacco unit shipment volume. The company believes that the current level of heated tobacco unit inventory is appropriate based on anticipated sales.
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)
First-Quarter
2021 2020 Change
Cigarettes
Marlboro 53,682 59,245 (9.4) %
L&M 20,367 22,641 (10.0) %
Chesterfield 12,758 12,903 (1.1) %
Philip Morris 10,184 11,463 (11.2) %
Parliament 8,957 7,573 18.3 %
Sampoerna A 8,698 8,548 1.8 %
Dji Sam Soe 5,704 6,175 (7.6) %
Bond Street 4,527 5,612 (19.3) %
Lark 3,899 4,025 (3.1) %
Sampoerna Hijau 2,199 1,477 48.9 %
Others 14,537 17,356 (16.2) %
Total Cigarettes 145,512 157,018 (7.3) %
Heated Tobacco Units 21,734 16,727 29.9 %
Total Cigarettes and Heated Tobacco Units 167,246 173,745 (3.7) %
Note: Sampoerna A includes Sampoerna; Philip Morris includes Philip Morris/Dubliss; and Lark includes Lark Harmony
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Our cigarette shipment volume of the following brands decreased: •Marlboro, mainly due toJapan ,North Africa ,the Philippines , PMI Duty Free andSpain , partly offset byTurkey ; •L&M, notably due toEgypt andPoland ; •Chesterfield, mainly due to the GCC andSpain , partly offset byBrazil andRussia ; •Philip Morris, primarily due toItaly andRussia ; •Dji Sam Soe inIndonesia , mainly due to Dji Sam Soe Magnum Mild; •Bond Street, notably due toRussia andUkraine ; •Lark, primarily due toJapan and PMI Duty Free; and •"Others," notably due to: mid-price Fortune inthe Philippines and Sampoerna U inIndonesia ; partly offset by low-price Morven inPakistan . Our cigarette shipment volume of the following brands increased: •Parliament, mainly driven byRussia ,Saudi Arabia andTurkey ; •Sampoerna A inIndonesia , primarily driven by premium A Mild; and •Sampoerna Hijau inIndonesia .
The increase in our heated tobacco unit shipment volume was mainly driven by the
EU (notably
First-Quarter 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 0.7 points to 26.8%, reflecting: •Total international market share for cigarettes of 23.3%, down by 1.4 points; and •Total international market share for heated tobacco units of 3.5%, up by 0.7 points. Our total international cigarette sales volume as a percentage of total industry cigarette sales volume was down by 1.2 points to 24.3%, mainly reflecting: out-switching to heated tobacco units, as well as lower cigarette market share and/or an unfavorable geographic mix impact, notably inJapan ,the Philippines , PMI Duty Free andUkraine , partly offset byTurkey . Financial Summary Financial Summary - Change Variance Quarters Ended March 31, Fav./(Unfav.) Fav./(Unfav.) 2021 2020 Total Excl. Total Cur- Price Vol/ Cost/ (in millions) Curr. rency Mix Other Net Revenues$ 7,585 $ 7,153 6.0 % 2.9 %$ 432 $ 225 $ 206 $ (31) $ 32 Cost of Sales (2,274) (2,402) 5.3 % 9.0 % 128 (87) - 29 186 Marketing, Administration and Research Costs (1) (1,849) (1,944) 4.9 % 2.4 % 95 49 - - 46 Amortization of Intangibles (18) (18) - % - % - - - - - Operating Income$ 3,444 $ 2,789 23.5 % 16.8 %$ 655 $ 187 $ 206 $ (2) $ 264
(1) Cost/Other variance includes a charge in 2021 for asset impairment and exit
costs of
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During the quarter, net revenues, excluding favorable currency, increased by 2.9%, mainly reflecting: a favorable pricing variance (notably driven byGermany ,Japan ,the Philippines andTurkey , partly offset byIndonesia ); and higher fees for certain distribution rights billed to customers in certain markets, shown in "Cost/Other"; partly offset by unfavorable volume/mix, primarily due to lower cigarette volume (mainly inIndonesia ,Japan ,North Africa ,the Philippines , PMI Duty Free andSpain ), partially offset by higher heated tobacco unit volume (notably in the EU,Japan andRussia , partly offset by PMI Duty Free).
The favorable currency in net revenues was due primarily to the Euro and Japanese yen, partially offset by the Russian ruble and Turkish lira.
Net revenues include$2.1 billion in 2021 and$1.6 billion in 2020 related to the sale of RRPs. IQOS devices accounted for approximately 6% of RRP net revenues in the first quarter of 2021, reflecting longer replacement times for existing users due to improving battery lives and reliability; and lower device prices in certain markets. Operating income, excluding favorable currency, increased by 16.8%, primarily reflecting: a favorable pricing variance; lower manufacturing costs (driven by productivity gains related to reduced-risk and combustible products); lower marketing, administration and research costs (largely driven by cost efficiencies, partially offset by the impact of 2021 asset impairment and exit costs of$48 million related to product distribution restructuring inSouth Korea and organizational design optimization); and higher fees for certain distribution rights, as noted above for net revenues.
Interest expense, net, of
Our effective tax rate decreased by 1.1 percentage points to 21.5%. The
effective tax rate for the three months ended
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$2.4 billion increased by$592 million or 32.4%. This increase was due primarily to higher operating income as discussed above. Diluted and basic EPS of$1.55 increased by 32.5%. Excluding a favorable currency impact of$0.10 , diluted EPS increased by 23.9%.
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 and nicotine-containing 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.
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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.
Much of the regulation that shapes the business environment in which we operate is driven by theWorld Health Organization's (the "WHO")Framework Convention on Tobacco Control (the "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, 182 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. InDecember 2020 , theWHO issued a report recommending substantial restrictions on the commercialization of heated tobacco products and e-cigarettes and the prohibition of e-cigarettes with open tank systems. It is not possible to predict whether or to what extent measures recommended by theWHO or the FCTC guidelines will be implemented. We believe that when better alternatives to cigarettes exist, the discussion should not be whether these alternatives should be made available to the more than one billion peoplewho smoke today, but how fast, and within what regulatory framework to maximize their adoption while minimizing unintended use. Therefore, we advocate for regulatory frameworks that recognize a significant difference on a risk continuum between combustible tobacco on the one hand and non-combustible tobacco and other nicotine-containing products on the other. Regulation should include measures that will accelerate switching to non-combustible products, for example, by allowing adult consumerswho would not otherwise quit to receive truthful and non-misleading information about such products to enable them to make informed decisions and by applying uniform product standards to enable manufacturers to demonstrate the safety of these products, as well as the absence of combustion. Regulation should also include specific rules for 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. Importantly, regulation must include measures designed to prevent initiation by youth and non-smokers. We support mandated health warnings, minimum age laws, restrictions on advertising, and public place smoking restrictions. We also support regulatory measures that help reduce illicit trade.
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. World Customs Organization Developments: In 2020, theWorld Customs Organization (the "WCO") amended the harmonized system nomenclature to introduce dedicated custom codes for novel tobacco and nicotine products, including heated tobacco products, e-cigarettes and other nicotine-containing products. The amendments will be effective as ofJanuary 1, 2022 . These amendments require WCO member states to transfer products from customs codes in the current nomenclature to the new one. These amendments are not expected to significantly impact current customs duty rates. EU Tobacco Products Directive: InApril 2014 , the EU adopted a significantly revised EU Tobacco Products Directive (the "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;
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•a ban on characterizing flavors in some tobacco products, with a transition period for menthol that expired inMay 2020 ; •security features and tracking and tracing measures that became effective inMay 2019 ; and •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 the introduction 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 . EU Tobacco Excise Directive:The EU Commission is preparing a legislative proposal for the revision of the 2011 EU Tobacco Excise Directive that may include definitions and tax treatment for novel tobacco and nicotine-containing products, including heated tobacco products and e-cigarettes. The proposal is expected to be finalized by the end of 2021. The adoption of the proposal will require unanimous agreement by all EU member states.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 ,Israel andDenmark , 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. Other countries may follow the EU's approach.Turkey banned menthol as ofMay 2020 . Broader ingredient bans have been adopted byCanada andBrazil .
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 and Use of Nicotine-Containing Products in Public: The pace and scope of restrictions on the use of our products 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 and use of nicotine-containing products in public and/or work places, 53
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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,South Africa banned the sale of tobacco products, e-cigarettes, and electronic devices that heat tobacco for several months during the COVID-19 pandemic. The ban, which was lifted onAugust 17, 2020 , 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 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. We generally estimate that, excludingChina and theU.S. , illicit trade may account for as much as 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 10% of total cigarette consumption in 2020. 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, 62 Parties, including theEuropean Union , have ratified it. The Protocol came into force inSeptember 2018 . Parties must 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. 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. 54
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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 by 2025 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.
For as long as a significant number of adult smokers continues to smoke,
responsible leadership of the category is critical. We aim to maintain our
competitive position in the cigarette market through selective investment. As a
leading international cigarette manufacturer, we will continue to accelerate
this transformation by using our regulatory and commercial expertise and
extensive commercial and distribution infrastructure as an effective platform
for the commercialization of our RRPs and communication with adult smokers and
trade partners about the benefits of switching to our RRPs.
While seeking to remain competitive in the cigarette market, we are judiciously reallocating resources from cigarettes to RRPs and are streamlining our cigarette portfolio.
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 smokerswho 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 smokerswho 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 thosewho 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 PMI-developed 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
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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 inAugust 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 smokerswho seek an alternative to cigarettes. The reduced exposure study results showed a substantial reduction in relevant biomarkers of exposure to the measured HPHCs in thosewho switched to Platform 2 compared to thosewho 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, which was completed in 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 our pharmacokinetic study related to the version without electronics indicate this product's potential as an acceptable alternative to continued cigarette smoking in terms of product satisfaction. InFebruary 2020 , we completed a one-month product use and adaptation study in adult smokers for the product variant without electronics. The results of the study indicated that while during the study period, the adult smokers did not fully switch from smoking cigarettes to this Platform 3 product, on average, they used this product on a daily basis and significantly reduced their daily consumption of cigarettes. We are working on product modifications to enable switching by those adult smokerswho are looking for better alternatives to cigarettes. Platform 4 covers e-vapor products, which are battery-powered devices that produce an aerosol by vaporizing a nicotine-containing liquid solution. In 2020, our e-vapor products comprised devices with the "coil and wick" technology as well as our e-vapor mesh technology designed to ensure the consistency and quality of the generated aerosol compared to the products with the "coil and wick" technology. Recently, we discontinued the commercialization of devices with the "coil and wick" technology. We conducted a nicotine pharmacokinetic study with respect to products with our e-vapor mesh technology in 2017. The results of this study indicate that these products are an effective means of nicotine delivery while being a satisfying alternative for e-cigarette users. InMarch 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 aim to expand our brand portfolio and market positions with additional RRPs. In addition, we are continuing to use our expertise, technology and capabilities to explore new growth opportunities beyond our current business, including products that do not contain nicotine or tobacco. After we receive the results of our scientific studies, including those mentioned above, in accordance with standard scientific practices, we share the conclusions in scientific forums and 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 and e-commerce. In order to accelerate switching to our Platform 1 products, our initial market introductions typically entail one-to-one consumer engagement (in person or by digital means) and device discounts. These initial commercialization efforts require substantial investment, which we believe will moderate over time and further benefit from the increased use of digital engagement capabilities. During the COVID-19 pandemic, we accelerated our investments in, and pivot to, digital consumer engagement. 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. As ofMarch 31, 2021 , PMI's smoke-free products are available for sale in 66 markets in key cities or nationwide. While our Platform 1 products are currently available for sale inMexico , that country banned the importation of e-cigarettes and devices that heat tobacco.
We believe that only a very small percentage of adult smokers
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.
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An adequate supply chain for our RRP portfolio, including the supply of electronic devices, is important to our business. We work with three electronics manufacturing service providers for the supply of our Platform 1 and Platform 4 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 one or more 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 example, currently, we are exposed to a world-wide shortage of semiconductors. While the impact of this development has not been significant, if this shortage intensifies, the supply of our electronic devices may be disrupted, which may affect our consumer acquisition and retention rates. For details on the impact of COVID-19 on our production and supply chain, see the "Executive Summary" section of this MD&A. We discuss product warranties in more detail in Note 14. 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:
•We started commercializing an improved version of our IQOS MESH product inNew Zealand ,Italy ,Finland and theCzech Republic under the IQOS VEEV or VEEV brand names. We currently plan to launch this product in additional markets.
•With respect to TEEPS, our Platform 2 product, we are finalizing our improvements to this product and plan to conduct a consumer test in 2021.
•Following the consumer test conducted in 2020 and the results of the product use and adaptation study described above, we are incorporating our learnings into our plans to improve our Platform 3 product.
Due to the COVID-19 pandemic, these plans may be delayed.
RRP Regulation and Taxation: RRPs contain nicotine and are not risk-free. As we describe in more detail above, we support science-based regulation and taxation of RRPs and believe that 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, 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, some governments have been and may continue to be temporarily 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. 57
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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, namely, IQOS 2.4 and three related consumables, 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. OnDecember 7, 2020 , the FDA reached the same determination for the IQOS 3 device and authorized that version of our Platform 1 product for sale inthe United States .
On
"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 from the date of the orders.
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. 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. These 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.
Some states and municipalities in the
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 were required to file a PMTA with the FDA bySeptember 9, 2020 . The FDA announced onSeptember 9, 2020 that it will prioritize enforcement against any tobacco and nicotine-containing product sold without a PMTA.
FDA actions may influence the regulatory approach of other governments.
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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 such products have been adopted in several countries with technical heat-not-burn specifications and/or methods for demonstrating the absence of combustion. They are mandatory inEgypt ,Jordan ,Saudi Arabia ,Tunisia and theUAE , and voluntary in theU.K. ,Russia ,Ukraine ,Kazakhstan ,Kyrgyzstan ,Tajikistan ,Vietnam , andIndonesia . InJapan , a voluntary standard sets minimum safety requirements for tobacco heating devices. We expect other governments to consider similar product standards and encourage making them mandatory. 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 such products, 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 filings. 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 . InAugust 2020 , the TGA issued its decision denying the application and stating that it did not present compelling evidence to establish a public health benefit from greater access to nicotine in heated tobacco products.
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 request with a local court seeking information underlying KFDA's analysis, conclusions and public statements. InMay 2020 , the court ordered KFDA to produce certain records. 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 do not accept e-cigarettes, heat-not-burn products may 59
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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. In 2020, theSuperior Health Council of Belgium ("SHC") published results of its inquiry into heat-not-burn products. The SHC concluded that heat-not-burn products, while not safe, have a more favorable toxicity profile than cigarettes. However, in light of the uncertainty of such products' short and long-term impacts, the toxic effects of the dual use with cigarettes, and the existence of approved smoking cessation tools, the SHC recommended that current regulations for cigarettes should apply to heat-not-burn products.
The foregoing scientific findings of government agencies may not be indicative of the measures that the relevant government authorities could take in regulating our products.
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 communication of the reduced exposure information authorized by the FDA in its MRTP marketing order described above. 60
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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. Other Developments: InSeptember 2017 , we announced our support of theFoundation for a Smoke-Free World . InSeptember 2020 , our pledge agreement with the Foundation was amended. We contributed$45 million in 2020 and expect to contribute$40 million in 2021 and$35 million annually from 2022 through 2029, as specified in the amended pledge agreement. To date, we contributed a total of$209.5 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 theDepartment of Special Investigations of the government ofThailand ("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. InDecember 2020 ,the Philippines andThailand agreed to pursue facilitator-assisted discussions aimed at progressing and resolving outstanding issues. It is not possible to predict any future developments in these proceedings or the outcome of these discussions. 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 inJuly 2020 andMarch 2020 , respectively, that it concluded a preliminary investigation against them for alleged contravention of anti-corruption laws and related disruption of trade freedom. 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. InSeptember 2020 , the Public Prosecutor referred the matter to trial. PM Italia believes the charges brought against it by the Public Prosecutor are without merit and will defend them vigorously.
Asset Impairment and Exit Costs
We discuss asset impairment and exit costs in Note 16. Asset Impairment and Exit Costs to our condensed consolidated financial statements.
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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 are 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 to confirm the absence of combustion and significant reductions of emissions of harmful chemicals compared to cigarettes. 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 .
In the third quarter of 2020, we launched commercial initiatives for licensed KT&G products in select markets.
Equity Investments
We discuss our equity investments in Note 12. Related Parties - Equity Investments 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
From time to time, 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.
We sell cigarettes in
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. Because we do business in certain of these countries, these state pension funds may have divested of our stock or may not invest in our stock. We do not believe such legislation has had a material effect on the price of our shares. 62
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Operating Results - Three Months Ended
The following discussion compares operating results within each of our operating segments for the three months endedMarch 31, 2021 , with the three months endedMarch 31, 2020 . Unless otherwise stated, references to total industry, total market, our shipment volume and our market share performance reflect cigarettes and heated tobacco units. Estimates for total industry volume and market share in certain geographies reflect limitations on the availability and accuracy of industry data.European Union : Change Variance Financial Summary - Fav./(Unfav.) Fav./(Unfav.) Quarters Ended March 31, Excl. Cur- Vol/ Cost/ (in millions) 2021 2020 Total Curr. Total rency Price Mix Other Net Revenues$ 2,909 $ 2,535 14.8 % 5.5 %$ 374 $ 235 $ 37 $ 102 $ - Operating Income$ 1,490 $ 1,158 28.7 % 15.2 %$ 332 $ 156 $ 37 $ 101 $ 38 During the quarter, net revenues, excluding favorable currency, increased by 5.5%, reflecting: favorable volume/mix, mainly driven by higher heated tobacco unit volume (notably inGermany andItaly ), partly offset by lower cigarette volume (notably inSpain ); and a favorable pricing variance (driven by higher combustible pricing, particularly inGermany ). Operating income, excluding favorable currency, increased by 15.2%, primarily reflecting: favorable volume/mix, driven by the same factors as for net revenues noted above; lower manufacturing costs (driven mainly by reduced-risk products); and a favorable pricing variance; partly offset by higher marketing, administration and research costs (including the impact of 2021 asset impairment and exit costs related to organizational design optimization).
Total market and market share performance are shown in the table below: European Union Key Data
First-Quarter
Change
2021 2020 % / pp
Total Market (billion units) 105.8 109.4 (3.3) %
PMI Market Share
Marlboro 17.1 % 17.6 % (0.5)
L&M 5.8 % 6.5 % (0.7)
Chesterfield 5.5 % 5.6 % (0.1)
Philip Morris 2.2 % 2.6 % (0.4)
HEETS 5.7 % 3.9 % 1.8
Others 3.2 % 3.2 % -
Total European Union 39.5 % 39.4 % 0.1
Note: HEETS includes HEETS Dimensions.
In the quarter, the estimated total market in the EU decreased by 3.3% to 105.8
billion units, notably driven by:
•Czech Republic, down by 24.9%, mainly reflecting lower border sales due to
pandemic-related lockdown measures;
•Denmark, down by 58.9%, or by 15.1% excluding the net unfavorable impact of
estimated trade inventory movements, primarily reflecting the impact of excise
tax-driven price increases;
•Romania, down by 12.8%, mainly reflecting the impact of pandemic-related
lockdown measures; and
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•Spain, down by 7.7%, notably reflecting lower in-bound tourism due to the
pandemic;
partly offset by
•Germany, up by 8.5%, primarily reflecting the pandemic-related impact of lower
cross-border (non-domestic) purchases and reduced out-bound tourism.
[[Image Removed: pm-20210331_g4.jpg]]
Our total shipment volume decreased by 4.7% to 43.2 billion units, or by 3.0%
excluding the net unfavorable impact of estimated distributor inventory
movements (notably in Spain ), reflecting:
•lower cigarette shipment volume, mainly due to the lower total market, as well
as lower market share (notably in Germany , Italy and Poland , partly reflecting
out-switching to heated tobacco units);
partly offset by
•higher heated tobacco unit shipment volume across the Region, driven by higher
market share (notably in Germany , Hungary , Italy and Poland ).
Eastern Europe :
Financial Summary - Change Variance
Quarters Ended March 31, Fav./(Unfav.) Fav./(Unfav.)
Excl. Cur- Vol/ Cost/
(in millions) 2021 2020 Total Curr. Total rency Price Mix Other
Net Revenues $ 796 $ 788 1.0 % 10.5 % $ 8 $ (75) $ 24 $ 59 $ -
Operating Income $ 261 $ 99 +100% +100% $ 162 $ 7 $ 24 $ 57 $ 74
During the quarter, net revenues, excluding unfavorable currency, increased by
10.5%, reflecting: favorable volume/mix, driven by higher heated tobacco unit
volume (primarily in Russia and Ukraine ), partly offset by unfavorable cigarette
volume (mainly in Ukraine ); and a favorable pricing variance, driven by higher
combustible pricing (notably in Ukraine ).
Operating income increased by over 100%, excluding favorable currency (note:
currency variance includes a favorable comparison due to an adverse transaction
currency impact in the first quarter of 2020 related to the revaluation of
foreign
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currency payables inRussia ), primarily reflecting: favorable volume/mix, driven by the same factors as for net revenues noted above; lower manufacturing costs (primarily related to reduced-risk products, mainly inRussia ); a favorable pricing variance; and lower marketing, administration and research costs.
In the quarter, the estimated total market inEastern Europe decreased, mainly due to: •Ukraine, down by 15.7%, or by 9.9% excluding the net unfavorable impact of estimated trade inventory movements, mainly reflecting the impact of excise tax-driven price increases and a higher prevalence of illicit trade; partly offset by •Russia, up by 3.6%, primarily reflecting the net favorable impact of estimated trade inventory movements, partly related to the ban on discounts on cigarettes effectiveApril 1, 2021 . Excluding these movements, the total estimated market decreased by 2.4%, mainly due to the impact of excise tax-driven price increases, partly offset by a lower prevalence of illicit trade. [[Image Removed: pm-20210331_g5.jpg]] Our total shipment volume decreased by 0.7% to 25.6 billion units, notably due to: •Ukraine, down by 10.9%, or by 7.7% excluding the net unfavorable impact of estimated distributor inventory movements, mainly reflecting the lower total market, partly offset by a higher market share driven by heated tobacco units; partly offset by •Russia, up by 4.2%. Excluding the net favorable impact of estimated distributor inventory movements of 0.4 billion cigarettes and 0.2 billion heated tobacco units, PMI's in-market sales increased by 0.3%, mainly reflecting the higher total market, partly offset by a lower market share due to cigarettes. 65
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Table of ContentsMiddle East &Africa : Financial Summary - Change Variance Quarters Ended March 31, Fav./(Unfav.) Fav./(Unfav.) Excl. Cur- Vol/ Cost/ (in millions) 2021 2020 Total Curr. Total rency Price Mix Other Net Revenues$ 801 $ 876 (8.6) % (5.9) %$ (75) $ (23) $ 77 $ (159) $ 30 Operating Income$ 335 $ 321 4.4 % 8.4 %$ 14 $ (13) $ 77 $ (130) $ 80 During the quarter, net revenues, excluding unfavorable currency, decreased by 5.9%, primarily reflecting: unfavorable volume/mix, mainly due to lower cigarette and heated tobacco unit volume in PMI Duty Free, as well as lower cigarette volume inNorth Africa (particularlyEgypt ); partly offset by a favorable pricing variance (driven by combustible pricing, mainly inTurkey ); and higher fees for certain distribution rights billed to customers in certain markets, shown in "Cost/Other." Operating income, excluding unfavorable currency, increased by 8.4%, mainly reflecting: a favorable pricing variance; lower marketing, administration and research costs; higher fees for certain distribution rights, as noted above for net revenues; and lower manufacturing costs; partly offset by unfavorable volume/mix, due to the same factors as for net revenues noted above.
In the quarter, the estimated total market in theMiddle East &Africa decreased, mainly due to: •International Duty Free, down by 58.4%, reflecting the impact of government travel restrictions and reduced passenger traffic due to the pandemic; and •South Africa, down by 29.2%, primarily reflecting a higher estimated prevalence of illicit trade resulting from the pandemic-related ban on all tobacco sales fromMarch 27, 2020 , throughAugust 17, 2020 ; partly offset by •Egypt, up by 7.6%, or by 4.6% excluding the net favorable impact of estimated trade inventory movements, notably reflecting a lower estimated prevalence of illicit trade and in-switching to cigarettes from other combustible tobacco products. [[Image Removed: pm-20210331_g6.jpg]] 66
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Our total shipment volume decreased by 8.0% to 28.0 billion units, notably due to: •Egypt, down by 16.6%, or by 9.1% excluding the net unfavorable impact of estimated distributor inventory movements, mainly reflecting a lower market share (notably for L&M); and •PMI Duty Free, down by 67.4%, or by 54.5% excluding the net unfavorable impact of estimated distributor inventory movements (due to cigarettes), mainly reflecting the lower total market for both cigarettes and heated tobacco units; partly offset by •Turkey, up by 7.9%, primarily reflecting a higher market share, driven by the growth of Marlboro andParliament , partly offset by a lower total market. South &Southeast Asia : Financial Summary - Change Variance Quarters Ended March 31, Fav./(Unfav.) Fav./(Unfav.) Excl. Cur- Vol/ Cost/ (in millions) 2021 2020 Total Curr. Total rency Price Mix Other Net Revenues$ 1,173 $ 1,251 (6.2) % (8.5) %$ (78) $ 28 $ (38) $ (68) $ - Operating Income$ 529 $ 599 (11.7) % (13.9) %$ (70) $ 13 $ (38) $ (72) $ 27
During the quarter, net revenues, excluding favorable currency, decreased by
8.5%, reflecting: unfavorable volume/mix, due to lower cigarette volume in
Operating income, excluding favorable currency, decreased by 13.9%, 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.
South &
In the quarter, the estimated total market in South &Southeast Asia increased, notably due to: •Indonesia, up by 4.9%, mainly reflecting the growth of the tax-advantaged 'below tier one' segment; and •Pakistan, up by 26.7%, or by 5.0% excluding the net favorable impact of estimated trade inventory movements, primarily reflecting a lower prevalence of illicit trade; partly offset by •thePhilippines , down by 14.4%, primarily reflecting the impact of industry-wide price increases in the fourth quarter of 2020. 67
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[[Image Removed: pm-20210331_g7.jpg]]
Our total shipment volume decreased by 7.1% to 34.9 billion units, notably due
to:
•Indonesia, down by 2.7%, primarily reflecting a lower market share, mainly due
to adult smoker down-trading to the 'below tier one' segment as a result of
significantly lower retail prices; and
•the Philippines , down by 23.9%, mainly reflecting the lower total market, and a
lower market share (due primarily to mid-price Fortune, reflecting the impact of
price increases in the fourth quarter of 2020, partly offset by Marlboro);
partly offset by
•Pakistan, up by 19.8%, primarily reflecting the higher total market.
East Asia & Australia :
Financial Summary - Change Variance
Quarters Ended March 31, Fav./(Unfav.) Fav./(Unfav.)
Excl. Cur- Vol/ Cost/
(in millions) 2021 2020 Total Curr. Total rency Price Mix Other
Net Revenues $ 1,472 $ 1,255 17.3 % 11.6 % $ 217 $ 71 $ 105 $ 41 $ -
Operating Income $ 695 $ 486 43.0 % 39.3 % $ 209 $ 18 $ 105 $ 58 $ 28 During the quarter, net revenues, excluding favorable currency, increased by
11.6%, reflecting: a favorable pricing variance, primarily driven by higher
heated tobacco and combustible pricing in
Operating income, excluding favorable currency, increased by 39.3%, mainly reflecting: a favorable pricing variance; favorable volume/mix, due to the same factors as for net revenues noted above; and lower manufacturing costs (primarily related to reduced-risk products inJapan ). Marketing, administration and research costs were essentially stable, despite the unfavorable impact of 2021 asset impairment and exit costs (primarily related to product distribution restructuring inSouth Korea ). 68
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In the quarter, the estimated total market inEast Asia &Australia , excludingChina , decreased, primarily due to: •Japan, down by 8.0%, primarily due to the impact of excise tax-driven price increases inOctober 2020 ; partly offset by •South Korea, up by 3.7%, mainly reflecting the shift of adult smokers from duty-free to domestic purchases due to the pandemic-related decline in international travel; and •Taiwan, up by 12.7%, mainly reflecting the same factor as forSouth Korea . [[Image Removed: pm-20210331_g8.jpg]] Our total shipment volume increased by 5.6% to 20.5 billion units, or decreased by 0.2% excluding the net favorable impact of estimated distributor inventory movements, notably reflecting: •Japan, up by 7.8%. Excluding the net favorable impact of estimated distributor inventory movements of 1.1 billion heated tobacco units (primarily driven by inventory movements in the first quarter of 2020), PMI's in-market sales decreased by 0.8%, mainly due to the lower total market, partly offset by a higher market share driven by heated tobacco units.Latin America &Canada : Financial Summary - Change Variance Quarters Ended March 31, Fav./(Unfav.) Fav./(Unfav.) Excl. Cur- Vol/ Cost/ (in millions) 2021 2020 Total Curr. Total rency Price Mix Other Net Revenues$ 434 $ 448 (3.1) % (0.7) %$ (14) $ (11) $ 1 $ (6) $ 2 Operating Income$ 134 $ 126 6.3 % 1.6 %$ 8 $ 6 $ 1 $ (16) $ 17 69
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During the quarter, net revenues, excluding unfavorable currency, decreased by 0.7%, mainly reflecting: unfavorable volume/mix, notably due to lower cigarette volume inColombia , partly offset byBrazil . Operating income, excluding favorable currency, increased by 1.6%, primarily reflecting: lower marketing, administration and research costs (mainly related to combustible products); partly offset by unfavorable volume/mix, due to the same factors as for net revenues noted above.
In the quarter, the estimated total market inLatin America &Canada increased, mainly due to: •Argentina, up by 14.2%, or by 9.4% excluding the net favorable impact of estimated trade inventory movements, primarily reflecting a lower estimated prevalence of illicit trade; and •Brazil, up by 8.3%, mainly reflecting a lower estimated prevalence of illicit trade due to: reduced price gaps with legal products and the impact of border restrictions imposed as a result of the pandemic. [[Image Removed: pm-20210331_g9.jpg]] Our total shipment volume decreased by 1.2% to 15.0 billion units, notably due to: •Colombia, down by 15.3%, primarily reflecting a lower total market, primarily due to the impact of price increases inJanuary 2021 and increased pandemic-related restrictions; partly offset by •Brazil, up by 9.7%, mainly reflecting the higher total market.
Excluding the net unfavorable impact of estimated distributor inventory movements, PMI's heated tobacco unit in-market sales volume in the Region increased by 10.1%.
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Cash Flow Highlights [[Image Removed: pm-20210331_g10.jpg]][[Image Removed: pm-20210331_g11.jpg]][[Image Removed: pm-20210331_g12.jpg]]
For the Three Months Ended March 31 ,
(in millions) 2021 2020
Net cash provided by operating activities $ 435 $ 1,111 Net cash provided by investing activities 55 514 Net cash used in financing activities (3,649)
(4,549)
Net Cash Provided by Operating Activities
During the first quarter of 2021, net cash provided by operating activities decreased by$0.7 billion compared with the first quarter of 2020. Excluding favorable currency movements of$0.2 billion , net cash provided by operating activities decreased by$0.9 billion , due primarily to higher working capital requirements of$1.3 billion , partially offset by higher net earnings. The higher working capital requirements in the first quarter of 2021 as compared with the first quarter of 2020 were primarily due to the timing of excise tax-paid inventory movements and excise tax payments, including the settlement of excise tax liabilities driven by the COVID-19 pandemic-related build-up of inventory. The higher working capital requirements were also due to lower usage of our factoring arrangements to sell trade receivables in the first quarter of 2021 compared with the first quarter of 2020. For further details on our factoring arrangements to sell trade receivables, see Note 13. Sale of Accounts Receivable.
Net Cash Provided by Investing Activities
During the first quarter of 2021, net cash provided by investing activities decreased by$0.5 billion compared with the first quarter of 2020. This change was primarily due to the movements in cash collateral exchanged with financial institutions to secure derivatives designated as net investment hedges of Euro assets principally related to changes in exchange rates between the Euro and theU.S. dollar. For further details on our derivatives designated as net investment hedges, see Note 5. Financial Instruments. The 2021 capital expenditures were primarily related to our ongoing investments in RRPs. We expect total capital expenditures in 2021 to be approximately$0.8 billion . 71
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During the first quarter of 2021, net cash used in financing activities decreased by$0.9 billion compared with the first quarter of 2020. The change was due primarily to lower long-term debt repayments ($1.6 billion in 2021 compared with$3.6 billion in 2020), partially offset by lower proceeds from short-term borrowings (primarily commercial paper).
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 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 three months endedMarch 31, 2021 and the full-year 2020, 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. AtMarch 31, 2021 , 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 29, 2021 , we entered into an agreement to amend and extend the term of our 364-day revolving credit facility fromFebruary 2, 2021 , toFebruary 1, 2022 in the amount of$1.75 billion . AtMarch 31, 2021 , our committed credit facilities were as follows: (in billions) Committed Credit Type Facilities 364-day revolving credit, expiring February 1, 2022 $
1.75
Multi-year revolving credit, expiringOctober 1, 2022
3.50
Multi-year revolving credit, expiring February 10, 2025(a) 2.00 Total facilities$ 7.25 (a) OnJanuary 29, 2021 , we entered into an agreement, effectiveFebruary 10, 2021 , to amend and extend the term of our multi-year revolving credit facility, for an additional year covering the periodFebruary 11, 2025 toFebruary 10, 2026 , in the amount of$1.86 billion .
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.
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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. AtMarch 31, 2021 , our ratio calculated in accordance with the agreement was 13.5 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$2.5 billion atMarch 31, 2021 and$2.7 billion atDecember 31, 2020 , are for the sole use of our subsidiaries. Borrowings under these arrangements and other bank loans amounted to$192 million atMarch 31, 2021 , and$244 million atDecember 31, 2020 . 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 . AtMarch 31, 2021 andDecember 31, 2020 , we had no commercial paper outstanding. The average commercial paper balance outstanding during the first quarter of 2021 was$0.9 billion . The average commercial paper balance outstanding during 2020 was$1.2 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 ofMarch 31, 2021 , andMarch 31, 2020 were$0.6 billion and$1.0 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 13. 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. Guarantees - AtMarch 31, 2021 , 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. InOctober 2020 , we guaranteed an obligation for an equity method investee. For further details, see Note 8. Contingencies to our condensed consolidated financial statements. 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 2020 and the first quarter of 2021, we did not repurchase any shares under a share repurchase program. Dividends paid in the first quarter of 2021 were$1.9 billion . During the third quarter of 2020, our Board of Directors approved a 2.6% increase in the quarterly dividend to$1.20 per common share. As a result, the present annualized dividend rate is$4.80 per common share. 73
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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 with maturities of 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 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," "aspires," "estimates," "intends," "projects," "aims," "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 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. Overall Business Risks 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 and health concerns, 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. 74
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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 volumes 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 (the "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 mandating 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 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 and use of tobacco and nicotine-containing products
in public and work places and, in some instances, in private places and outdoors;
• restrictions or prohibitions of novel tobacco or nicotine-containing products;
• 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. More specifically, 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 could have a material adverse effect on our financial results. 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.
We are subject to income tax laws in
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such changes could have a material adverse impact on our effective tax rate thereby reducing our net earnings. Further changes in the tax laws of foreign jurisdictions could arise as a result of the base erosion and profit shifting project undertaken by theOrganisation for Economic Co-operation and Development , which recommended changes to numerous long-standing tax principles. If implemented, such changes, as well as changes in taxing jurisdictions' administrative interpretations, decisions, policies, or positions, could also have a material adverse impact on our effective tax rate thereby reducing our net earnings. In future periods, 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. Risks Related to our International Operations Because we have operations in numerous countries, our results may be adversely impacted 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. Such improper or unlawful conduct (actual or alleged) could lead to litigation and regulatory action, cause damage to our reputation and that of our brands and result in substantial costs. 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. Risks Related to Legal Challenges and Investigations 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 in which we operate. 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." 76
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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 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 be adversely impacted. Intellectual property rights of third parties may limit our ability to commercialize our products or improve product quality 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, commercialize and improve our 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. Risks Related to our Competitive Environment We face intense competition, and our failure to compete effectively could have a material adverse effect on our profitability and results of operations. We are subject to highly competitive conditions in all aspects of our business. 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. 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, volume and regulatory 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, 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. 77
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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 effective adult consumer engagement, including communication about product
characteristics and usage of RRPs;
• provide excellent customer care;
• 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 be materially adversely impacted as a result. Such down-trading trends may be reinforced by regulation that limits branding, communication and product differentiation.
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 be adversely impacted 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, and the intended
benefits from our investments may not materialize.
One element of our growth strategy is to expand 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/or anticipated revenue
improvements and cost savings. There is no assurance that we will be able to
acquire attractive businesses or enter into strategic business relationships on
favorable terms ahead of our competitors, or that such acquisitions or strategic
business development relationships will be accretive to earnings or improve our
competitive position. In addition, we may not have a controlling position in
certain strategic investments or relationships, which could impact the extent to
which the intended financial growth and other benefits from these investments or
relationships may ultimately materialize.
Our ability to achieve our strategic goals may be impaired if we fail to
attract, motivate and retain the best global talent and effectively align our
organizational design with the goals of our transformation.
To be successful, we must continue transforming our culture and ways of working,
align our talent and organizational design with our increasingly complex
business needs, and 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, motivate and retain the best global talent with the right
degree of diversity, experience and skills to achieve our strategic goals.
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Risks Related to the Impact of COVID-19 on our Business
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 have and will continue to
adversely impact our business, results of operations, cash flows and financial
position while the pandemic continues. Our business continuity plans and other
safeguards may not be effective to mitigate the impact 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 and the willingness of adult consumers to switch to our
RRPs, and adversely impact 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 COVID-19 pandemic in general
and specifically in the jurisdictions in which we operate, 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.
Risks Related to Sourcing of Materials, Products and Services
Use of third-party resources may negatively impact quality of our products and
services, and we may be required to replace third-party contract manufacturers
or service providers with our own resources.
We increasingly rely on third-party resources to manufacture some of our
products and product parts (particularly, the electronic devices and
accessories) and to provide services, including to support our finance and
information technology processes. While many of these arrangements improve
efficiencies and decrease our operating costs, they also diminish our direct
control. Such diminished control may have an adverse effect on the quality of
products or services, our supply chain, and the speed and flexibility in our
response to changing market conditions and adult consumer preferences, all of
which may place us at a competitive disadvantage. In addition, we may be unable
to renew these agreements on satisfactory terms for numerous reasons, including
government regulations, and our costs may increase significantly if we must
replace such third parties with our own resources.
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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. Furthermore, crop quality may 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. Risks Related to the Success of our Reduced-Risk Products 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 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 information and 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 smokers
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 information and claims. Such restrictions could limit the success of our RRPs. Our RRPs and commercial activities for these products are designed for, and directed toward, current adult smokers and users of nicotine-containing products, and not for non-smokers or youth. If nonetheless there is a significant usage of our products or competitive products among youth or non-smokers, even in situations over which we have no control, our credibility may suffer, and our efforts to advocate for the development of science-based regulatory frameworks for the commercialization of RRPs may be significantly impacted. 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. Although we have received these product authorizations from the FDA, there is no guarantee that the product will remain authorized, particularly if there is a significant uptake in youth or non-smoker initiation. 80
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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 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. If we cease to
be successful in these efforts, RRP unit margins may be adversely affected.
Risks Related to Illicit Trade
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 that Marlboro 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 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.
Risks Related to Cybersecurity and Data Governance
The failure of our information systems to function as intended or their
penetration with the intent to corrupt them or our failure to adhere to strict
data governance and cybersecurity protocols and to comply with privacy laws and
regulations could result in business disruption, loss of reputation, 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 work with our internal specialists
and these third-party service providers to protect these systems and data from
unauthorized access. Nevertheless, failure of these systems to function as
intended, or penetration of these systems by 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 data governance and 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, and as privacy laws in the
jurisdictions in which we do business become more stringent, the magnitude of
these risks is likely to increase.
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