Philip Morris International Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. PMI manufactures and sells cigarettes, other tobacco products and nicotine-containing products outside the United States. Financial statements are unaudited.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net revenues | $21.335B | $20.629B | $60.165B | $59.639B |
| Net revenues excluding excise taxes | $7.856B | $7.927B | $22.570B | $23.428B |
| Gross profit | $5.122B | $5.309B | $14.766B | $15.620B |
| Operating income | $3.345B | $3.599B | $9.170B | $10.327B |
| Net earnings attributable to PMI | $2.155B | $2.340B | $5.881B | $6.589B |
| Diluted EPS | $1.38 | $1.44 | $3.73 | $4.02 |
- Q3 reported revenue rose 3.4%, but revenue excluding excise taxes declined 0.9%. For the nine months, reported revenue rose 0.9%, while revenue excluding excise taxes fell 3.7%. Price increases were offset by unfavorable currency and volume/mix.
- Operating income declined 7.1% in Q3 and 11.2% for the nine months. Calculated operating margin was approximately 15.7% in Q3 versus 17.4% a year earlier, and 15.2% for the nine months versus 17.3%.
- Q3 diluted EPS declined 4.2%; nine-month diluted EPS declined 7.2%. Excluding the reported unfavorable currency effects, management said EPS increased 9.7% for Q3 and 5.7% for the nine months.
- Q3 cigarette shipment volume declined 0.4%; nine-month volume declined 2.4%. Nine-month cigarette and other tobacco product volume, on a cigarette-equivalent basis, declined 2.2%.
- Nine-month operating cash flow was $6.385B, down from $7.815B. Capital expenditures were $804M; investing cash outflow was $773M and financing cash outflow was $5.562B. Cash ended at $2.043B, versus $2.154B at year-end 2013.
- Total debt was approximately $28.8B, up from $27.7B at December 31, 2013; long-term debt was $25.395B and short-term borrowings $2.091B. Cash less total debt implies net debt of approximately $26.8B.
- Current assets were $14.761B and current liabilities $15.117B. PMI had $8.0B of committed revolving credit facilities, fully undrawn, and $834M of commercial paper outstanding. Its covenant EBITDA-to-interest ratio was 13.2:1 against a 3.5:1 minimum.
- Nine-month dividends declared were $2.88 per share and dividends paid totaled $4.471B. The quarterly dividend was increased 6.4% to $1.00 per share; annualized rate was $4.00. PMI repurchased $3.0B of shares in the first nine months.
Material changes and segment trends
- Currency was a major headwind: it reduced nine-month net revenues by $3.5B and operating income by $977M. Management cited, among others, the Argentine peso, Indonesian rupiah, Japanese yen, Russian ruble, Turkish lira and Ukrainian hryvnia.
- Price increases supported results, but were offset by unfavorable volume/mix, higher manufacturing costs and currency. Excise taxes on products increased 3.8% in the nine-month period.
- EEMA operating companies income increased 8.4% for the nine months, supported by pricing and higher equity income from North Africa and Russia. Asia operating companies income fell 26.7%, reflecting currency, volume/mix and manufacturing costs. European Union income fell 10.9%, including Netherlands closure charges; Latin America & Canada income fell 5.4%.
- PMI recorded $503M of nine-month asset impairment and exit costs, compared with $8M a year earlier. These were primarily associated with factory closures in the Netherlands, Australia and Canada. The Netherlands program included $472M recorded through September; total pre-tax program charges were estimated at approximately $542M.
Guidance, management commentary and risks
- On October 16, 2014, PMI forecast full-year reported diluted EPS of $4.76–$4.81, versus $5.26 in 2013. Adjusted EPS was projected to grow approximately 6.5%–7.5% from adjusted 2013 EPS of $5.40. The forecast included an approximately $0.72-per-share unfavorable currency impact, a $300M productivity and cost-savings target and a $4.0B share-repurchase target. Adjusted EPS is a non-GAAP measure; guidance excludes future acquisitions, unanticipated charges, future currency changes and unusual events.
- Management cited continued excise-tax increases, declining cigarette markets, illicit trade, down-trading and intense competition. Foreign exchange movements, political and economic instability, regulation, and pricing approvals may also affect results.
- The revised EU Tobacco Products Directive entered into force in May 2014, with member-state implementation required by May 2016. PMI challenged aspects of the directive; proceedings and other packaging, marketing and product restrictions remain uncertain.
- Tobacco litigation remained substantial. PMI reported 64 individual smoking-and-health cases, 11 class actions and 15 health-care cost recovery cases, among others. Management said no loss was considered probable and estimable for pending tobacco-related cases, so no estimated loss was accrued; it warned an adverse outcome could materially affect a period’s results, cash flows or financial position.
- PMI disclosed Thai investigations alleging approximately $2.0B of customs-duty and excise-tax underpayments for 2003–2007 and an informal inquiry alleging approximately $1.8B for 2000–2003. The company said criminal charges were probable in the first matter and disputed the allegations.
- PMI is developing reduced-risk products, but stated that it may not substantiate risk-reduction claims or obtain regulatory approval. Planned iQOS city tests in Japan and Italy were scheduled for late 2014; no reduced-risk claims were planned pending studies and, where required, approval.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing stated there were no material changes to the risk factors in the 2013 Form 10-K.
Important facts for investors to verify
- Whether pricing and cost savings can offset ongoing currency pressure, falling cigarette volumes and market down-trading.
- Actual progress and total cash costs of the Netherlands, Australia and Canada closures, including the expected timing of remaining payments.
- Whether 2014 reported and adjusted EPS guidance, the $300M savings target and $4.0B repurchase target are achieved; review the non-GAAP adjustments and currency assumptions.
- Debt maturities, refinancing needs, cash generation and liquidity, including the extent of reliance on commercial paper and revolving facilities.
- Developments in tobacco litigation and the Thai investigations, including any change in management’s assessment of probability, estimability or potential exposure.
- Regulatory outcomes affecting packaging, ingredients, marketing and reduced-risk products, and evidence supporting the commercial outlook for PMI’s new product platforms.