Philip Morris International Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; comparative period is Q1 2015. PMI manufactures and sells cigarettes, other tobacco products and nicotine-containing products outside the United States, across four geographic segments. Financial statements are unaudited.
Financial performance and position
| Metric | Q1 2016 | Q1 2015 / prior date |
|---|---|---|
| Net revenues | $16.788 billion | $17.352 billion; down 3.3% |
| Net revenues excluding excise taxes | $6.083 billion | $6.616 billion; down 8.1% |
| Gross profit | $3.987 billion | $4.387 billion |
| Operating income | $2.473 billion | $2.871 billion; down 13.9% |
| Net earnings attributable to PMI | $1.530 billion | $1.795 billion; down 14.8% |
| Diluted and basic EPS | $0.98 | $1.16; down 15.5% |
| Operating cash flow | $462 million provided | $375 million used |
| Cash and cash equivalents | $2.944 billion | $3.417 billion at Dec. 31, 2015 |
| Total debt | $29.8 billion | $28.5 billion at Dec. 31, 2015 |
Net revenues excluding excise taxes fell primarily from unfavorable currency ($691 million) and volume/mix ($114 million), partly offset by price increases ($272 million). Operating income declined mainly from currency ($378 million), volume/mix ($183 million) and higher marketing, administration and research costs ($135 million), partly offset by pricing and lower manufacturing costs. The effective tax rate was 28.3%, compared with 30.2%; Q1 2015 included a $58 million adverse tax item related to repatriation assertions.
Capital expenditures were $226 million, primarily for reduced-risk products (RRPs), productivity programs and new-product equipment. Dividends paid were $1.585 billion; dividends declared were $1.02 per share. Total stockholders’ deficit was $10.894 billion at quarter-end.
Segment performance
| Segment | Net revenues | Operating companies income | Income change year over year |
|---|---|---|---|
| European Union | $6.143 billion | $906 million | Down 2.3% |
| Eastern Europe, Middle East & Africa | $3.997 billion | $633 million | Down 26.9% |
| Asia | $4.689 billion | $778 million | Down 16.7% |
| Latin America & Canada | $1.959 billion | $229 million | Down 0.4% |
Cigarette shipment volume declined 1.4% to 196.0 billion units (1.7% excluding favorable estimated inventory movements). Asia was down 7.0%, principally reflecting Indonesia, Pakistan and the Philippines; the other three segments reported shipment growth. PMI attributed the overall earnings decline chiefly to currency and weaker volume/mix.
Liquidity, debt and capital
PMI issued $2.0 billion of U.S. dollar notes in Q1, with maturities from 2019 to 2026, and used proceeds for general corporate purposes. It had $8.0 billion of committed revolving credit facilities, fully available, with no borrowings under those facilities and no commercial paper outstanding at March 31. The covenant EBITDA-to-interest ratio was 10.2:1 against a minimum of 3.5:1. S&P and Fitch had negative outlooks on their A ratings; Moody’s outlook was stable on its A2 rating.
Operating cash flow improved from the prior-year use of cash, with management citing favorable currency movements, lower exit-cost payments and lower working-capital requirements. Cash flow also benefited from receivables sales: $1.9 billion of trade receivables were sold in Q1, versus $0.3 billion in Q1 2015; $589 million of sold receivables remained outstanding at quarter-end. PMI said the 2016 cash-flow comparison also reflected timing of excise-tax payments and inventory movements.
Outlook and management commentary
On April 19, 2016, PMI raised its full-year 2016 reported diluted EPS forecast to $4.40–$4.50 at then-prevailing exchange rates. The company estimated an unfavorable currency impact of about $0.45 per share and described the forecast as 10%–12% growth versus 2015 adjusted EPS of $4.42, excluding that currency impact. The forecast excludes share repurchases, future currency changes, acquisitions, unanticipated impairment or exit charges, and unusual events. PMI forecast international cigarette volume, excluding China and the U.S., to decline about 2.0%–2.5%, and estimated a full-year effective tax rate of approximately 28%.
Management said currency remained a significant headwind. PMI does not plan share repurchases in 2016. Its European Union restructuring program, begun in 2015, is expected to finish by the end of 2017 and carry total pretax charges of approximately $93 million; no impairment or exit costs were incurred in Q1 2016.
PMI continued expanding iQOS, its heated-tobacco RRP, and began commercial production at its Bologna-area facility in Q1 2016. It planned to submit a U.S. FDA Modified Risk Tobacco Product application for Platform 1 late in 2016, while noting there is no assurance regulators will authorize reduced-risk claims or commercialization on those terms. The company reported reduced exposure biomarkers in clinical studies but had not marketed iQOS with reduced-risk claims.
Risks, contingencies and unusual items
- Litigation: PMI reported 66 individual smoking-and-health cases, 11 class actions, 16 health-care-cost recovery actions, three individual “lights” cases and three public civil actions pending as of April 22, 2016. Management had not concluded that a loss was probable or could be estimated for pending tobacco cases, so no loss provision was recorded; it cautioned that an adverse outcome could materially affect results, cash flows or financial position.
- Quebec class actions: 2015 trial rulings included a CAD 131 million punitive-damages award in Letourneau and approximately CAD 15.5 billion in compensatory damages in Blais, with PMI’s subsidiary allocated approximately 20% of the Blais compensatory award. Both rulings were appealed. A court ordered PMI’s subsidiary to furnish CAD 226 million of security across the two cases; a second quarterly installment of approximately CAD 37.6 million (about $29.7 million) was paid in March 2016. Merits appeals were scheduled for November 2016.
- Thailand customs matter: In January 2016, prosecutors charged PMI’s Thai subsidiary and seven current or former employees over alleged under-declaration of import prices for 2003–2006 entries and sought a fine of approximately THB 80.8 billion (about $2.30 billion). PMI’s subsidiary disputes the allegations; the case was in the pre-trial evidentiary phase. Separately, the filing describes a Thai investigation concerning alleged underpayment of approximately $1.8 billion for 2000–2003 imports.
- Regulatory and business risks: PMI highlighted excise-tax increases, declining cigarette consumption, illicit trade, competition and down-trading, extensive tobacco regulation and packaging/marketing restrictions, foreign-exchange exposure, political and economic uncertainty, and the possibility of adverse litigation or government investigations. It noted that EU tobacco-product rules were due for implementation by May 2016 and that court decisions on EU rules and UK plain packaging were pending.
- Other exposure: Tax examinations could change unrecognized tax benefits, interest or penalties, but PMI could not estimate a possible change. PMI was contingently liable for $0.7 billion of guarantees of its own performance, primarily excise-tax related; no associated liability was recorded.
Most important facts for investors to verify
- Whether the $4.40–$4.50 EPS forecast and 2.0%–2.5% volume-decline estimate remain achievable, given currency movements and market conditions.
- Whether the improvement in operating cash flow is sustainable, considering receivables sales, working-capital timing and currency effects.
- Debt growth, dividend funding and credit-rating outlooks, alongside the company’s available committed facilities and covenant headroom.
- Developments in the Quebec appeals and security requirements, and the potential financial and operational consequences of the Thai customs prosecution.
- RRP adoption, scientific evidence and regulatory decisions, including the planned FDA application and the economics of commercialization.