Philip Morris International Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. PMI manufactures and sells cigarettes and other tobacco products outside the United States. Financial statements are unaudited; amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net revenues | $21.051bn | $20.483bn | $38.830bn | $39.010bn |
| Net revenues excluding excise taxes | $7.797bn | $7.917bn | $14.714bn | $15.501bn |
| Gross profit | $5.101bn | $5.216bn | $9.644bn | $10.311bn |
| Operating income | $2.874bn | $3.337bn | $5.825bn | $6.728bn |
| Net earnings attributable to PMI | $1.851bn | $2.124bn | $3.726bn | $4.249bn |
| Diluted EPS | $1.17 | $1.30 | $2.35 | $2.58 |
| Operating margin, calculated on reported net revenues | 13.7% | 16.3% | 15.0% | 17.2% |
Excise taxes on products were $13.254bn in Q2 and $24.116bn in the first half. Six-month cigarette volume fell 3.5% to 418.8bn units; Q2 volume fell 2.7% to 222.8bn. Price increases partly offset unfavorable currency and volume/mix. For the first half, currency reduced net revenues excluding excise taxes by $1.0bn; pricing added $900m and unfavorable volume/mix reduced them by $670m.
Cash flow: First-half operating cash flow was $3.420bn, down from $4.500bn; capital expenditures were $508m. Investing used $544m and financing used $3.487bn. Cash declined $613m to $1.541bn. Operating cash flow was affected by lower earnings, exit-cost payments and working-capital movements.
Debt and liquidity: Total debt was approximately $29.5bn at June 30, versus $27.7bn at year-end; cash was $1.541bn. Short-term borrowings were $1.941bn and long-term debt, including current portion, was $27.568bn. PMI had $8.0bn of committed revolving facilities, fully undrawn, and reported a 13.7x covenant EBITDA-to-interest ratio against a 3.5x minimum. Current assets exceeded current liabilities by approximately $1.13bn. Stockholders’ deficit was $7.847bn.
Material changes and unusual items
- Q2 operating income declined 13.9%; first-half operating income declined 13.4%. PMI attributed the declines chiefly to currency, unfavorable volume/mix, manufacturing costs and factory-closure charges.
- First-half diluted EPS fell 8.9% to $2.35; Q2 diluted EPS fell 10.0% to $1.17. PMI said EPS excluding currency effects increased 3.1% for the first half and 1.5% for Q2.
- Asset impairment and exit costs were $512m pre-tax for the first half, including $488m for the planned Netherlands factory closure and $24m for an Australian factory closure program. The Netherlands program is expected to cost about $560m pre-tax in total; production was planned to cease by September 1, 2014. Approximately $439m of exit liabilities remained at period-end, with payments expected substantially by Q2 2015.
- PMI acquired U.K. e-vapor company Nicocigs for $103m net of cash acquired, with contingent payments of up to $77m. The acquisition was not material to reported results.
- First-half dividends paid were $2.993bn and share repurchases were $2.281bn in the cash-flow statement. PMI’s 2014 repurchase target was $4.0bn.
Outlook, commentary and risks
PMI reaffirmed 2014 reported diluted EPS guidance of $4.87–$4.97, compared with $5.26 in 2013. Adjusted diluted EPS, a non-GAAP measure, was projected to grow 6%–8% versus $5.40 in 2013. The outlook included an estimated $0.61 per-share unfavorable currency impact, a $300m productivity and cost-savings target, and a $4.0bn share-repurchase target. Management cautioned that Australian down-trading and discounting, together with plain packaging, could put currency-neutral adjusted EPS growth at the low end of the range. Guidance excludes future currency changes, acquisitions, unusual events and unanticipated charges.
Key risks include declining cigarette consumption, excise-tax increases, down-trading and illicit trade; extensive tobacco-product, packaging and marketing regulation; foreign-exchange movements; political and economic disruption; and litigation and government investigations. The revised EU Tobacco Products Directive entered into force in May 2014, with member-state implementation due by May 2016; PMI subsidiaries sought judicial review. Plain-packaging proposals were also under consideration in several countries.
PMI reported 92 tobacco-related cases pending as of July 30, 2014. Management said no loss was considered probable and estimable for pending tobacco-related cases, so no estimated loss was accrued; an adverse outcome could nevertheless materially affect results, cash flows or financial position. In Thailand, authorities proposed charges concerning alleged customs and excise underpayments of about $2bn for 2003–2007, and an informal inquiry covered about $1.8bn for 2000–2003; PMI said criminal charges were probable. PMI disputes the allegations.
PMI was developing reduced-risk products, but stated there was no assurance that products would substantiate risk-reduction claims or receive regulatory approval. It planned city tests of its iQOS system in Japan and Italy in Q4 2014, without reduced-risk claims pending studies and any required approvals.
Investor verification priorities
- Track cigarette volume, pricing, market share and currency effects, particularly in Asia, Russia, Mexico and Australia.
- Verify the full cost, cash timing and operational effects of the Netherlands and Australia closures against the stated estimates.
- Monitor debt growth, cash generation, dividends and share repurchases, and confirm continued covenant headroom and access to financing.
- Follow tobacco litigation and the Thailand investigation, including whether any loss becomes probable or estimable.
- Assess delivery of EPS guidance and the assumptions behind currency, cost savings, repurchases and Australian market conditions.