Philip Morris International Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. Unaudited U.S. GAAP statements. PMI manufactures and sells cigarettes and other tobacco products outside the United States across four geographic segments.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net revenues | $20.037bn | $20.234bn | $38.059bn | $36.764bn |
| Gross profit | $5.454bn | $5.429bn | $10.460bn | $9.925bn |
| Operating income | $3.604bn | $3.712bn | $7.007bn | $6.719bn |
| Net earnings attributable to PMI | $2.317bn | $2.409bn | $4.478bn | $4.328bn |
| Diluted EPS | $1.36 | $1.35 | $2.60 | $2.42 |
| Cash from operations | Not provided for quarter | Not provided for quarter | $5.378bn | $6.515bn |
Reported gross margin was approximately 27.2% in Q2 and 27.5% for the first half, using net revenues that include excise taxes. Operating margin on the same basis was approximately 18.0% and 18.4%, respectively. First-half free cash flow, calculated as operating cash flow less capital expenditures, was approximately $4.902bn, versus $6.170bn a year earlier.
- Revenue and volume: First-half reported revenue rose 3.5%; revenue excluding excise taxes rose 3.3% to $15.568bn. Cigarette volume increased 1.8% to 457.4bn units. In Q2, reported revenue fell 1.0% and cigarette volume fell 1.2%.
- Profit and EPS: First-half operating income rose 4.3% and PMI-attributable earnings rose 3.5%. Q2 operating income declined 2.9% and PMI-attributable earnings declined 3.8%, while diluted EPS increased 0.7% to $1.36.
- Cash and investment: First-half operating cash flow declined $1.137bn, reflecting currency and higher working-capital needs. Capital expenditures were $476m, up from $345m.
- Debt and liquidity: Total debt was $20.8bn at June 30, up from $18.5bn at year-end; cash was $3.846bn, up from $2.550bn. Current liabilities of $16.830bn exceeded current assets of $15.561bn. PMI had $6.0bn in committed facilities, none drawn, and $2.4bn of commercial paper outstanding. Its covenant EBITDA-to-interest ratio was 16.2x against a 3.5x minimum.
- Capital returns: First-half dividends paid were $2.663bn and share repurchases were $3.059bn. Dividends declared were $1.54 per share for the first half, versus $1.28 a year earlier.
Material changes and drivers
- First-half operating growth was led by EEMA and Asia, supported by pricing and, in EEMA, favorable volume/mix. The European Union and Latin America & Canada segments reported lower operating companies income.
- Q2 results were pressured by unfavorable currency, volume/mix, and higher marketing, administration and research costs. PMI attributed much of the year-over-year comparison in Asia and Q2 volume to the 2011 Japan supply disruption, which had added 6.3bn shipments and approximately $0.10 to 2011 Q2 EPS.
- For the first half, currency reduced reported revenue by $2.0bn and revenue excluding excise taxes by $494m. Price increases were a key offset, adding $832m to first-half revenue excluding excise taxes.
- First-half comprehensive earnings attributable to PMI were $3.965bn, down from $5.206bn, chiefly reflecting unfavorable currency translation in other comprehensive income.
- PMI reported a stockholders’ deficit of $1.116bn at June 30, compared with positive equity of $551m at year-end, reflecting repurchases, dividends and accumulated comprehensive losses.
Outlook, management commentary and risks
- 2012 guidance: On July 19, PMI reaffirmed full-year reported diluted EPS guidance of $5.10–$5.20, versus $4.85 in 2011. It forecast approximately $0.27 per-share unfavorable currency impact; currency-neutral EPS growth was projected at approximately 10%–12% versus adjusted 2011 EPS of $4.88. Guidance excludes potential acquisitions, unanticipated impairment or exit charges, and unusual events.
- Management cited a 2012 gross productivity and cost-savings target of approximately $300m, primarily from manufacturing and procurement initiatives. It expected the EU cigarette market decline in the second half to be similar to the first-half decline.
- PMI planned €500m–€600m of NGP factory investment over three years, with first-factory readiness expected by 2016 and launches in initial markets anticipated in 2016–2017. Regulatory approval and successful commercialization are not assured.
- Key business risks include rising excise taxes, declining cigarette consumption, downtrading, illicit trade, currency movements, competition, and increasingly restrictive tobacco regulation. Australia’s plain-packaging rules were scheduled to take effect December 1, 2012; PMI was pursuing legal challenges. Brazil’s proposed ingredient restrictions and potential EU regulatory changes were also noted.
- Litigation and contingencies: PMI stated it had not concluded that losses in pending tobacco cases were probable or could be reasonably estimated, and had accrued no estimated losses for those cases. It warned an adverse outcome could materially affect results, cash flows or financial position. Thai authorities had proposed charges alleging approximately $2bn in duties and taxes for 2003–2007 and were informally investigating another approximately $1.8bn for 2000–2003; the first matter remained under review after a prosecutor’s non-prosecution order.
- The existing $12bn repurchase program was completed July 31, 2012; a new $18bn three-year program began August 1. The filing reported no material changes to previously disclosed risk factors and stated disclosure controls were effective.
Most important facts for investors to verify
- Whether full-year EPS guidance of $5.10–$5.20 was achieved, and how actual currency effects compared with the forecast.
- Whether operating cash flow and working capital recovered after the first-half decline, alongside the effect of increased capital spending.
- Debt and liquidity trends, including commercial-paper refinancing and continued compliance with credit-facility covenants.
- Developments in major litigation and investigations, particularly the Thai tax matters and tobacco-related cases for which potential losses were not estimable.
- Regulatory outcomes affecting packaging, ingredients, excise taxes and marketing, and the cost, timing and approval prospects of next-generation products.
- Execution and funding of the new share-repurchase program, and the effect of repurchases and dividends on leverage and the balance sheet.